Trading psychology is as vital a skill as performing technical and fundamental analysis to identify trading opportunities. This is because if you don’t have the mental strength to only make conscious trades, you will find yourself making impulsive trades. Such emotion-led trades have led many traders to irretrievable losses. For this reason, we’ve developed a checklist that every trader should ensure they satisfy before making any trade.
Why is a trading checklist important?
A trading checklist is a list of questions that every trader should satisfy before committing to a trade. It can come in handy because it can help you stay disciplined and un-wavered in your trading plan. Additionally, it can boost your confidence in your decision-making as it increases your chances of making winning trades.
A trading checklist is often mistaken for a trading plan. However, a trading plan involves details such as the analysis plan you intend to follow and the currency pair you’re trading. A trading checklist, on the other hand, outlines the conditions that must be met before a trade can be executed. Without further ado, let’s dive into our checklist.
Trading psychology checklist
Before executing any trade in the markets, here are the questions you should ask yourself to avoid making rash decisions:
- Is the market bullish, bearish, or in consolidation?
- Are prices at, or are they approaching a level of support and resistance?
- Do indicators support the viability of this trade?
- What’s my risk to reward ratio?
- How much of my capital do I stand to lose if it goes wrong?
- Is there any piece of economic news that can affect my trade?
- Am I sticking to my trading plan?
Trending vs. consolidating markets
Usually, most expert traders look for strong trends and opportune entry and exit points. Trading in such a trend’s direction is likely to return a profit, even if you’re a little late in making your entry. However, you should always be on the lookout for reversals, as all great trends are just reversals waiting to happen.
There is a class of traders that prefers to trade in ranging markets. These are periods when the price fluctuates between a support and resistance level. These consolidation periods are more common in the Asian session. Though they offer little in the way of pips of profit, such periods are easy to trade as getting entry and exit signals are much easier.
Support and resistance levels
Support levels occur when prices decline to a point where market supply reduces, and demand overpowers it, causing an increase in prices. Once this recurs a few times at the same level, it is said to have formed a valid support level.
Resistance, on the other hand, occurs when prices skyrocket to a point where there is no more demand for the underlying asset. This causes prices to embark on a downtrend. Recurrent reversals at this point make it a valid resistance level.
Range traders use support and resistance levels as entry and exit signals. Other traders wait for sustained breakouts from these levels because they may signify the beginning of a major trend.
All the best trading opportunities must be pointed out by a couple of indicators. For this, you could choose MA crossovers, RSI, stochastics, Bollinger Bands, or any other suitable indicator in the market. However, you should ensure you do not over-complicate your analysis by using too many indicators at once.
Risk to reward ratio
This is the ratio of the pips a trader is willing to lose in order to achieve a certain profit level. This ratio comes in handy when setting stop-losses and take-profits. As a rule of thumb, the minimum risk to reward ratio you should go for is 1:1. This means that you risk just as much as you stand to gain. A ratio of 1:2, 1:3, or higher is even better.
How much capital is at risk?
You should never risk more than 5% of your total capital on a single trade. You should carefully approach position sizing to determine where to place your stop losses. Further, most traders make the mistake of using too much leverage on their trades. Granted, this can lead to increased profits, but in the event, the market goes against you, you stand to lose great amounts. To avoid this, you should limit your leverage to ten to one or lower.
Economic news affecting the trade
Oftentimes, natural disasters, acts of terror, or failures in the markets cause major price movements. These can be hard to predict for most traders. However, there are other scheduled events on the economic calendar that affect currency prices. These include GDP data, employment data, CPI, and interest rate decisions, among others. You should keep up to date with the economic calendar so that any moves caused by these releases do not catch you off-guard.
Following the trading plan
As aforementioned, the trading plan includes things such as what market you wish to trade and the analysis techniques you intend to follow to obtain trade signals. It is very important that you stick to the trading plan because failure to do so will lead you to make the impulsive decisions you’re trying to avoid. This could lead you to losses which will tamper with your confidence.
Honorable mention: using expert advisors
Another way to avoid emotional trading is to utilize forex robots, otherwise known as expert advisors (EAs). These are programs that automate the trading process, obtain trade signals using predetermined parameters, and can also execute trades on your behalf. However, before choosing an EA, you should do extensive research to ensure it is legitimate.
Emotional trading is one of the ways most traders record continuous losses, even to the point of blowing their accounts. To avoid this, one should only make premeditated decisions when entering into trades. To aid in this, we have compiled a list of seven questions you should satisfactorily answer before placing a trade. If you follow these steps to the letter, you are guaranteed to be in more control of your trading decisions, which will ultimately lead to sustained profits. Further, you can utilize automated trading by employing EAs in your trading account.