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Kane Trading
on:
The Critical Elements of a
Trade
In this article I will lay out the Kane Trading
philosophy on what I consider to be the critical elements of a trade. I
frequently refer to the sum of these elements as the 'Plan for a Trade', and
hence I use these phrases interchangeably. This article is designed to be an
overview, not a fully detailed, all encompassing treatise. I only point this
out so that it is clear what the purpose and scope of this article actually
is.
I am
going to present the critical elements, and explain in some detail a little bit
about each element. After digesting the article it is my hope that you will
understand the concept of a trade as I see it. At this point you can then go
about making your own decisions on how you can develop these areas into a
personalized plan for you, a plan that fits your own goals, risk tolerances,
and individual lifestyle.
Notice that I'm emphasizing 'you' a lot. That's part of
the larger scale Kane Trading philosophy. I don't believe there is a plan that
can be given to you, and then off you go, an instant success. I feel that you
must develop each component on an individual basis, never losing sight of the
fact that it must be custom tailored to you and your needs. What I want to
provide here are what I feel to be the critical elements, so that when you work
on your plan for trades (note that this is different than
the all-encompassing 'Trading (or Game) Plan'), you will have an idea of
what you need to include in this plan.
Is it possible there are other
important elements that you should have in your plan that I won't mention?
Absolutely. Once you get to understand my way of thinking, this question
won't even be worth asking; you'll already know the answer. I am presenting
what I feel are the critical elements of a trade, for me. I could
never presume to know if they are the entire group of critical elements for
you.
That is a big part of what I am attempting to teach with this
website, and the products that I offer on it. You must develop your own plan,
your own trading style, based on you. I want to present things that I wish I
had known; things that I wish I had been shown early on, because I feel that
these things would have saved me time and money. You look them over and decide,
on your own, to use, modify or reject the things which I present. With all that
said, I will present my elements, and leave it to you, the reader, to use all
or part of them, and to add others if you feel the need to.
The 4 critical
elements of a trade:
1) Potential trade area (PTA):
You want a reason why you think this is an area where
you want to be involved
in this issue
2) Entry technique: You then want a trigger
that tells you, once in the area where
you want to become
involved in the trade, that now is the time
3) Trade size: You
must decide, by doing some simple calculations, what the trade size
will be
4) Trade management: You want to have a
plan in place, before you even
consider
getting in
the trade, that tells you how you will manage this trade, whether it goes
for
you or against
you
I can't
emphasize enough, though; these are not the elements of the 'so called'
'Trading (or Game) Plan'. (Please see my very brief free article entitled
Kane Trading on: The Difference Between a 'Plan for a
Trade' and the 'Trading Plan'.) These are the four elements that I feel
are critical to initiating a specific trade.
These four elements say nothing about how
much capital you would use on the trade, how much capital you would be willing
to put at risk, what trading vehicle(s) you might use (futures, options and/or
option combinations, single stock futures, stock, etc.), and so on. These
things are part of the 'Trading Plan', or 'Game Plan', as it is sometimes
called. Here we are looking at just one piece of the larger scope 'Trading
Plan', the immediate and critical elements that get you into a specific trade.
With all that said, let's look, now, at the four elements in a bit more
detail.
In
element number one, we are looking for an area that we want to trade in. This
area is determined by whatever style and technique you have in your larger
scope 'Trading Plan'. An example that might be a part of this element could be
determination of potential support or resistance on the timeframe the trade is
going to be traded on. The entire book Kane Trading on: Advanced Fibonacci Trading
Concepts revolves around element number one.
In that book I purposefully tried
hard to focus on using the techniques I presented just to find areas where a
trade might be considered. I continually mention, probably to the dismay of
some of my readers, how I will avoid much discussion on entry and management
techniques. The reasoning is that I want to present material that doesn't span
across the four critical elements, when possible. This way, if a trader is
seeking information on just one of the elements, he or she doesn't have to pay
for, and wade through, material that isn't of interest.
So the gist of element one is to
find an area that you think is a 'value area' for a trade. A place where you
think that the reward/risk is to your favor, and where you feel that you have
an edge. To do this, you must develop specific techniques that specialize in
fulfilling this need. The book mentioned above is just one of many, many
possible ways to fulfill this need. Traders must determine, for themselves, how
they want to meet the needs for this element.
Element number two is the specific
entry technique. This logically comes after you have decided on an area where
you are willing to take a trade. Now that you want in, do you just jump in?
Only if you want to get squashed like a bug. This is where all those sayings
come into play, sayings like 'Don't try to catch a falling piano…' and so
on. The entry technique tries to keep you out of trades that aren't behaving
the way you would expect that they would be behaving, in the area you have
determined that you might take a trade.
One of the things that I want to point out is
how the first two elements compliment each other. I see many traders using
similar techniques to the entry techniques that I present in
Kane Trading on: Entry Techniques,
but using them as their sole criterion to enter a trade. Let me present an
analogy of sorts.
I remember a study I once heard someone talking about on the
effectiveness of the 'snap back reversal' as an entry technique. The study, as
best as I can remember it, compared the snap back reversal as a stand-alone
technique to its use in conjunction with a potential support or resistance area
in an established trend. Without getting into the exact details, or into
critiquing the study, here's the main point of what was found. As a stand-alone
technique, the snap back reversal failed miserably, something like less than
ten percent effective. On the other hand, when combined with an 'area to trade'
(in the form of potential support or resistance), the effectiveness jumped way
up, to something like over seventy percent effective.
Again, instead of getting involved
in critiquing the methods used, let's focus on what the essence of this study
shows us. It's clear that the entry technique alone was pretty useless, but
when combined with a well-chosen 'area to trade', it seemed to blend and form a
synergy. In my experience, that is exactly what happens. That's why I emphasize
the critical elements of a trade the way I do.
I've seen traders who are pretty
good at finding areas to trade, but they choose to trade without any entry
techniques at all. If it 'hits the zone', they are in. I also see these same
traders from time to time, squished to the pavement, under a fallen piano
filled with concrete, as the issue showed no respect for the area at all. Good
entry techniques can frequently provide the confirmation needed to keep one out
of most of those falling piano trades.
I've also seen traders take entry
techniques and just apply them whenever they appear. An example I've seen is
using moving average crossovers whenever they appear, regardless of any
context. Sure, you may catch a few nice long trends doing that, but the rest of
the time you'll likely get chopped to whipsaw pieces and give back more than
you'll ever make with the few trends that you catch. This is the opposite side
of the coin, using an entry technique without it being in an 'area to
trade'.
Element number three is the determination of the size of the trade.
To make this calculation I need three things. I need the dollar amount that I
am willing to risk, the protective stop loss point, and the entry point. Some
simple arithmetic then gives me the trade size. Understand that this section is
a simple calculation of the trade size, and no more.
This section does not cover
calculating or deciding the amount to risk, maximum allowable trade size, or
anything of that nature. Those things come from the master 'Trading Plan', and
are 'imported' into this section for use in the calculations of trade size.
This section is only included as a critical element of a trade because in order
to initiate any trade you must say what size you want the trade to be. The
scope of this element, in the context of the 'Plan for a Trade', is strictly
limited to this one simple calculation.
The fourth critical element is management of
the trade. Now why is management, something that happens after the trade is
initiated, lumped into this plan, with the things that get us into a trade?
Simple. It's critical to determine how you will manage the trade
before you enter the trade. The reason for that is pretty simple. You
don't want to be making critical decisions in the heat of battle.
When I enter a
trade, I have already decided how I will react to every possible outcome. I
mean that literally, every possible outcome. I figure out every possible
variation on the outcomes and pre-decide what I will do. This way I can be an
execution robot when in a trade. All decisions are made in the calm cool of the
off-market hours. Then when I trade, I am simply looking for certain 'patterns'
and when I find them, I make my decision as to whether or not I want to take
the trade.
If I do choose to take the trade, I already know where my initial
protective stop will be, how and when I may take profits (note that this does
not necessarily mean 'profit targets'), how I may move up my stops on a trail,
and so on. Every trade I get into, and I mean every single one, you could
freeze time at that point and say "Jim, say it goes up x points to here, turns
and goes down y points, then turns and… what would you do?" I will be able
to answer instantaneously without thinking, every trade, every time.
I have developed
this skill over many, many years of trading, and I can do it 'instantaneously',
because I evolved to doing a fair amount of daytrading, where 'instantaneously'
is the slowest that you can be. Any delay and you are toast. In position
trading or swing trading, with timeframes that may range from 2-5 days and up,
you have a little 'lag time' to double check your plan, and then execute the
pre-determined management guidelines (assuming, of course, that you aren't in
the midst of a 'market shock' event).
This in no way implies that the guidelines
aren't fully pre-determined, it simply implies that perhaps you don't have to
be able to spit them out off the top of your head in an instant. For some
traders, it's fully adequate to have the management guidelines written out in
detail right next to the computer, and to utilize them that way. The greater
point is that they are fully planned out ahead of time, before the trade is
initiated.
This is all pretty commonsensical, if you think about it.
Management may be required one millisecond after the trade is initiated. We've
all had trades where we swear 'The Universe', or 'The Market', or whatever, is
out to get us, because the instant we initiate a trade it turns and goes like a
rocket against us. (I'm fond of saying, perhaps all too often, "That's what
stops are for.") I don't want to be in a situation like that and have to figure
out, on the fly, how I want to manage the trade, or where my stops should be.
There is no time for figuring out anything at that point; you must be able to
just react. Also, in many types of trades, you may want to put the initial
protective stop order in with the original entry order.
Another scenario,
albeit a more pleasant one to deal with, is when a position you are in rockets
in your favor, a real blow-off move. When do you take profits? Some say 'What's
the difference, you're making a nice profit regardless?' I feel that you must
maximize this golden opportunity. To do so, you need to have a management plan
in place, such as a trailing stop on some of the position. But how much of the
position, and what kind of a trailing stop? (See
Kane Trading on: Trade Management
and Kane Trading on: Trailing Stops
for more information on this topic.) If the market explodes, especially in
daytrading, you don't want to be thinking 'What do I do now?' The time to
decide things like this is before you even put on the trade.
So those are the
four elements that I consider critical to entering a trade, with a whole lot of
my personal thoughts included along the way. The reason behind my presenting
this article is to make clear how I look at various aspects that I consider
critical to planning a trade. This way, readers can see the 'mindset' of the
Kane Trading philosophy, and decide if it makes sense to them. Please note,
though, that this article wasn't designed to provide detail in each of the
areas outlined. It was designed simply to present the areas, and explain what
each area encompasses.
I am pointing this out because as the article progressed, I made
references to books and articles that I offer, in order to provide sources for
some of the detail and content that is outlined in this article. I personally
dislike websites (some of them actually paid websites) where every article is
clouded in references to techniques that are part of materials the writer has
for sale. The writer tells you basically nothing, but hooks you into thinking
that the hidden secrets he or she sells are where it's at.
The point, then, of
sites like that, is to tell you enough to make you think you need to buy their
products. The articles are then embedded with dozens of links to their
products, and every reference to what technique you should use is another
hotlink to buy another product. Why mention all this? Because I want to make it
clear that this article, and this website, are not designed in this way. I make
references above to help the reader locate products on this site that are
pertinent to the area that we are exploring at the time, in order to save the
reader time trying to search the site to find additional material, if they feel
they want to further pursue that topic.
I feel this article is a 'stand alone'
article. I think the content is very valuable. I wish I had found this simple
layout when I started trading. I didn't see the difference way back then
between an area to trade and an entry technique, and so on. If you don't want
to purchase any of the Kane Trading products mentioned, or any other products
on the site, that is fine. If you have found anything valuable for you in this
free article, please use it.
Nothing in this article requires any Kane Trading
products or techniques to be used. You can choose your own areas to trade, your
own entry techniques and your own management plan. If you already have all
that, but didn't see how they fit together, then perhaps this article has
clarified a few things. What I want to make clear is that this free article is
designed to introduce some critical Kane Trading concepts and give you a chance
to see aspects of my approach, not to try to hype and suck you into buying
products.
But I also need to make it clear that the purpose of the site is to
provide quality trader education and for me to make a few bucks doing
it, as outlined on the About Kane
Trading page. If all I did were free articles I wouldn't be able to cover
my expenses, nor make any money. So I have to balance some promotion of the
products that I have for sale with good, quality cross-referencing for the
readers benefit. I hope that I have struck a reasonable balance and made clear
where I stand, all the while presenting some valuable information for the
reader.
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