The Logic Behind Trading Decisions

By | April 4, 2015

The Logic Behind Trading Decisions: I’ve written before on this site that I think it’s crucial every trader should develop a trading strategy that fits who he or she is. Please note that I chose to use the word ‘develop’ instead of, let’s say, ‘find’. That’s because, as far as I know, and I’ve researched this subject extensively, all great traders and investors have developed their own style which eventually made them rich and famous. They didn’t just stumble on someone else’s trading strategy and copied it exactly.

An easy way to find out whether a trader follows a well thought out process or is just haphazardly clicking the ‘Sell’ and ‘Buy’ buttons on his platform is to ask him about the logic behind his trades. No matter if he’s using Elliot Wave, Gann angles, chart patterns, Fibonacci numbers, or a chart full of indicators, can he logically communicate the reasons for taking the trades ?

I will present examples of two of my EUR/USD trades, one which resulted in a loss, the other one in a gain, with full rationale for entering and exiting. The goal in doing this is to get people to question more in regard to their trading decisions before risking hard-earned money.

1. The losing trade

Long EUR/USD 1h time-frame

Long EUR/USD M15 time-frame

Questions: a) What’s the significance of those two lines and the moving average (MA) ?

The MA (set on 200 periods) helps me quickly gauge where the price is in comparison with its recent past. If the price is too far away from the MA it indicates the fact that on the time-frame in question the move is overextended and a period of consolidation or correction is highly probable. The two lines unite the recent higher lows – the support – and lower highs – the resistance – of the price, delimiting what is usually called a continuation triangle.

b) What’s the reason for entering the trade ?

Following a contraction of volatility, the price broke through the resistance in the early London session. Expecting a continuation of the move higher and considering the good risk/reward level – close to the break out point , I entered the trade.

c) What’s the reason for closing the trade ?

The price didn’t follow through, in other words, it didn’t act as it was supposed to act when the trade was opened.

A speculator must concern himself with making money out of the market and not with insisting that the tape must agree with him. Never argue with it or ask it for reasons or explanations. – Jesse Livermore

2. The winning trade

Long EUR/USD 1h time-frame

Questions: a) What’s the reason for entering the trade ?

The trade was entered as the price broke out of a consolidation that lasted a few days. This marked a major higher low in EUR/USD after the multi-year low registered in mid March. The level at which it was entered offered a very favorable risk/reward ratio, with a stop loss placed just below the former resistance, now turned into support line.

b) What’s the reason for closing the trade ?

The trade was opened on Thursday with the belief that if it’s not stopped right away because of a fake break-out, the only expected risk event left would be the NFP on Friday. You could exit a profitable long trade in one of two ways: either selling into strength or wait for the price to come back until it breaks some former resistance turned support. As one of my trading rules is to not keep open positions over weekend, I just closed the trade soon after NFP was released.

To conclude, if you can’t find the logic behind your trading decisions, I think you should ask yourself one question: is it logical to continue to trade in an illogical way ?