Editor's note: This is Part 1 of a four-part series on trade entry and exit. Subsequent installments will explore the rest of the trade life cycle, through the exit of the trade and the post-trade assessment.
What do you remember about your first trade? If you’re like many traders and investors, you can recall quite a few details about that first plunge. Was it a retail investment such as a stock purchase, or were you working as a professional trader or investor? What made you decide to make that trade at that time? Had you just obtained your first investable assets—maybe a paycheck, bonus, gift, or inheritance? Were you nervous?
Perhaps as important as those details were the logistical details of the trade. Was it made online, via touch tone, or on the phone with a live broker? How did you research that first trade? Did you employ technical analysis, fundamental analysis, or both? Do you still have the position in your portfolio, or have you since closed that position? What did you learn from the process, and what have you learned since then?
The success of every trade is defined by three elements: the entry point, the exit point, and what happens in between. This "On/Off Ramp" series will explore the ins and outs of trade entries and exits—the decision-making process, the signals and patterns, the tools that can help you decide when to get in and out of a trade, and what to consider while a position is on the books.
Understanding the full trade life cycle from start to finish, plus the mechanics and thought processes that accompany each phase, may help you more fully pursue your trading and investing goals.
Part 1: The Pre-Trade Process
So you’ve got your trading account open and you’re ready to trade, huh? Well, don’t hit that big green or red button just yet; it’s not enough to just want to trade. The first step in trading should be to define the reason for the trade, which should be more than just a gut feeling, or your brother-in-law’s opinion. You should have a thorough understanding of why you’re making this trade, and in general, objectivity is better than subjectivity. Some traders say that subjectivity can invite fear, greed and a host of other factors that lead to bad decision making.
It may help to ask yourself “What’s my objective in making this trade?” And most likely, “making money” isn’t going to cut it as an answer. Perhaps you are eyeing an earnings report as the springboard for a move. Or maybe a stock you’ve been watching move lower looks to have found a bottom and may be heading higher. Maybe you just want to get in on a stock that’s trending. Whatever the reason, having a solid objective not only helps define your reason for getting into a trade, as we’ll see in a later part in this series, it can also help you get out of a trade.
Fortunately, certain tools within the thinkorswim® platform from TD Ameritrade make it easier to define your objective. For instance, that stock you think may have found a bottom (or a top)? The chart in figure 1 shows user-friendly charting tools to help you consider your entry.
From plain candlestick or line charts, to sophisticated pattern recognition studies, you can easily go from simple to complex depending on your level of comfort. The goal is to help you more clearly define your reason for making the trade.
Thinkorswim can also help you with fundamental analysis. Publicly-held companies are required to publish their financial statements on a quarterly and annual basis. But rather than spend hours scouring the internet to gather company information, you can simply log on to thinkorswim and click on the Analyze tab, and then the Fundamentals page, where you’ll find a plethora of company fundamentals, from activity ratios to valuations. Fundamental information alone might form the basis for your trade, or it could be used in conjunction with your technical analysis. Additional information tools include live news feeds and custom watch lists. The tools are there; the choice is yours.
So, for example, your trade objective might pull from several sources, such as a bullish technical signal, plus an strong earnings release, bolstered by a news item. That’s a much more reasoned objective than, say, hearing your brother-in-law talk about how awesome the stock is.
Making your objective, well…objective, rather than subjective and touchy-feely can help eliminate the elements that may lead to bad decision making. And in Part 2, we’ll see how this can potentially help you while the trade is playing out. Are you ready? You may proceed with the trade.
Want to conduct your own market analysis?
Learn how certain techniques and charts can help as you determine when to consider buying and selling stocks using Technical Analysis.