How To Make A Trade

How do you actually make a trade? What thoughts go through your head, what items are on your mental checklist? The answer will, of course, be different for all of us. However what I’m gonna try to do here is create a model trade – a template if you will. This template is aimed at newbies who know the basics of spread betting – leverage, stop losses, going short etc… but need some way of stringing it all together. More experienced traders, please read and make comments at the bottom of the post. I have no monopoly on trading knowledge so come one, share some of yours.

I’m going to try to come up with a 9-step process (sounds like an AA plan or, even worse, a self-help programme)! I’ll try to cover all the basics and I’ll, errr…. try to do it in a blog that only takes a few minutes to read. Gulp!

Guiding Principles

Before I launch into this I’m going to set out a couple of principles that I think are critical for new traders.

• Learn, Then Earn: Trading is not an easy way to make money – it takes some discipline and some knowledge. So some of the rules set out here aren’t necessarily set out to maximise your profits, but they are designed to get you up the learning curve as soon as possible
• Emotions Are Your Biggest Enemy: When people start trading they often underestimate the effects of fear, greed and even boredom on their trading. Where a tool helps to reduce these, I don’t hesitate to recommend it.

Right, let’s dive in.

Step 1 – Choose A Timeframe

If you are just starting out your trading timeframe will probably be determined by your daily routine rather than anything else. If you can trade through the day then you might have a timeframe of a few hours: i.e. your ideal scenario will be to enter a trade and then exit it (for a healthy profit, of course) a few hours later. However if you are aiming to trade in the evenings only you might have a timescale of a few days – so your ideal trade will be closed (and your profits made) perhaps three days after opening it.

Either way, your timeframe will inform what you do in much of the rest of this process.

Step 2 – Choose A Market

Hah, tricky one this. spread betting providers typically offer a bewildering variety of instruments: indices, currencies, commodities and literally thousands of shares.

If you are interested or have a feel for a particular market, I suggest you start there. For example if you have been investing in shares for years, go with that. Don’t let a flashy headline about oil or a friend’s comment about the US Dollar distract you. Build on what you already know. Do keep to the larger shares though – tighter spreads will make it easier to turn a profit.

If you don’t have any particular starting point then all I can do is offer some general advice, and invite others to comment below.

• Avoid markets that are (or can be) fairly thin in liquidity. Oil trading, for example, is dominated by a relatively small number of banks. Same might be true for any number of the smaller currency pairs.
• Avoid massively volatile markets (i.e. ones where the price jumps around like a hare on amphetamines). Volatility isn’t a bad thing but it does require good risk management, and that’s something that needs to be learnt.

So where do you start? If you really have no preference I’d suggest either indices or currencies. Both have tight spreads and both are sufficiently well-traded that it is hard for any one player or players to be to affect the price.

By the way you might find it interesting to know what most spread betting clients bet on. Indices are generally the most popular bets, followed by currencies.

One final piece of advice before I leave this step. When starting out it is better to choose one instrument, learn about it and give it a proper go. Initially you need to find out the characteristics of that instrument – for example the DAX has far more manufacturing companies than most indices, while at the time of writing Ireland’s ISEQ20 ETF is heavily dominated by just one company, CRH. Later on you’ll get a feel for the more abstruse stuff, like what which pieces of news are more likely to affect its price and what times of day are the best to trade it.

Step 3 – Choose A Strategy

Most of the literature for new traders emphasises the need for a strategy, but maddeningly they rarely explain what a strategy is!

When talking about strategies, the first thing to consider is how to make your trading decisions. There are two main approaches to consider: those that are based on fundamental knowledge and those that are based on graphs.

Fundamental decision makers generally rely on having a good knowledge of what is going on in their market and making decisions based on whether they think an asset is under-priced or over-priced. If, as a fundamentals bod, you think something is under-priced (perhaps because the price has over-reacted to some bad news) then you buy (go long). The assumption is that others will soon realise what you know and the price will rise. Conversely if you think something is over-priced (perhaps it has over-reacted to some good news) then you sell (go short). Either way, if you are right you make money and if you are wrong you lose it.

Technical Analysis (TA) strategies rely on using and interpreting graphs. There are hundreds of Technical Analyses out there. If you want to read up on them we have some great blogs on the basics of charts, moving averages, Fibonacci levels and much more.

However an example of a simple TA strategy might be to find an instrument that is range-bound, i.e. having trouble breaking through its support and resistance levels. If the instrument approaches it’s support level then buy it and hold it until it has either returned to the middle of it’s range (when you sell and take your profit) or it breaks through the support (when you sell, take your loss and move on to the next trade).

These two approaches are the two ends of a scale, and most people sit somewhere in between. A mechanical trading system  is as close to pure technical analysis as you can get. However  if the system threw up a trade that he fundamentally disagreed with you might still not consider taking it.

Where will you sit on this scale? Trading is a voyage of self discovery …(cue mystical music).

Step 4 – Choosing A Direction

If you think a price is going to rise you ‘go long’ and if you think a price is going to fall you ‘go short’. Simple, no? And yet one of the most frequent mistakes we see are clients who have a ‘long bias’ – in other words they are more likely to go long irrelevant to whether the market is trending upwards or downwards.

Even a cursory glance at a FTSE chart for 2008 shows that short positions on UK shares were more likely to win than longs ones. Nevertheless throughout 2008 we saw a substantial number of our clients trying to trade the bounces – and many failed.

Maybe we, as humans, prefer to go long because by nature we are optimists. Maybe the media coverage of stocks is largely aimed at investors who can only go long, and that influences us. Whatever the reason, spread betting allows us to go long or short, and to be successful we need to be as ready to trade in one direction as the other.

Step 5 – Choosing Entry And Exit Points

Once you’ve chosen the instrument and the direction you want to trade it, the next item on the agenda is to choose the points you want to get in and out.

How you do this will be completely dependent on the approach you chose in step 3. For a fundamental approach there simply aren’t any hard and fast rules. Text book theory says that one should work out the theoretical value of a stock (based on concepts like discounting the value of the company’s future earnings). However that approach is much better suited to long-term investing than short-term trading. More likely a fundamental approach will see people make judgements about whether something is over-valued or under-valued, and then either use their gut feel or graphs to choose an entry point.

By comparison, a Technical Analysis approach might make the entry quite straightforward. For example, if you are using the range-bound strategy from above and you instrument is trading in a range of 100 points, your entry point may be when the price reaches within 10 points of the resistance level.

Step 6 – Exit Points

Once you are in a trade one of two things will happen: the price will move for you or it’ll move against you.

If the price moves for you there are any number of ways of deciding when to exit the trade and take your profits.

One of the oldest maxims in the trading world is to ‘cut your losses and let your profits run’. Which means that if the price is moving in your favour then you shouldn’t close the trade until the trend reverses. It’s one exit strategy but (and I know a lot of people will disagree with me) I don’t recommend it. Not for new traders anyway. Following that strategy requires you to make a decision during the trade, at a time when the trader’s enemies of fear and greed will be at their most potent.

Other alternatives include deciding on a profit target from the outset or using trailing stop losses. Both are easier on the old emotions!

Of course the price might move against you too. So, before you put on a trade, decide where you want to get out of the trade. And then, once the trade is on, move your stop loss to this level. Again there are no rules I know of regarding a fundamental approach to setting stop losses. Maybe that’s why many people use Support and Resistance or Moving Averages to help. Anyway there’s plenty more about stop losses here but to start with remember to keep things simple.

Step 7 – Decide On Your Bet Size

The size of your bet (i.e. the stake) bet and your stop loss level are the main things that determine the risk of the trade – and managing your risk is critical to being a good trader. The theory says you should decide on how much of your starting balance you are willing to risk. Once you’ve decided that, and if you know where your stop loss should be you can work out the bet size.

As an example let’s say you have €5000 in your account. You want to risk no more than 5% of that: €250. If your stop loss is 50 points away from where you’ll enter the bet, then your stake can be no more than €5 (as €5 x 50 points = €250).

Step 8 – Run The Bet

At this point you should know what market you want to bet on. You should also have a ‘strategy’ in that you know what direction to trade, where you will get in, what your profit target is and where your stop loss will be. Voila! You have a strategy.

Now comes the easy part … wait to see if your entry point is reached and, if it is, spring into action. Put on the trade and, once done, don’t forget to move your stop loss to where you want it. Oh, and be careful not to bend your rules. Better to let a few trades get away than to break your trading discipline – at least at first.

It also makes a lot of sense to test your strategy on a demo account before risking any of your own hard-earned dosh.

Step 9 – Assess, Learn And Finesse

Once the bet is closed you’ll know immediately whether it has worked or not. But to find out if your strategy is any good you’ll need to run it for a good few bets. If it’s not working you might look at changing things around.

That’s All Folks

And that’s it. I’ll end with one last piece of advice. Trading is hard work, but it can be rewarding both financially and in other ways. So enjoy it! If you loose that sense of enjoyment you’ll lose the most valuable part of trading.

Hopefully this article will be of some use to beginners and, if you are an experienced trader, please do add your comments below. Share some of your hard-earned know-how by e-mailing us at adminATspread-betting.com – you were a new kid once too!