Quite often, aspiring traders enter the market without a reason and blindly open a position, anticipating a certain price movement. This can be compared to crossing the street without having a look both ways. In order to make entering the market “safer”, a trader may create a trade setup that needs to be present to even consider a trade.
An entry trigger is when a predetermined trade setup meets certain criteria to initiate a trade. These criteria are defined by traders as situations with high trading potential. It can be a breakout of major support/resistance levels, the appearance of certain price chart patterns, a specific state of technical indicators, or all of these things combined. Some traders use entry triggers as a way to automate their trades.
Here are some tips on how to prepare a trade setup for entry triggers and what traders should keep in mind when entering a trade.
Collecting Trading Filters
Trade filters identify market conditions that are supposed to precede an entry trigger. These filters are often established through backtesting or general market observation. For example, traders may use historical market data to identify market conditions when the price experiences significant change and creates high trading potential. Traders can use this information for further automation of trades or for building their own trading strategy, once the same market conditions occur.
However, not all trading filters can be easily defined by raw market data. A significant portion of technical analysis is dedicated to chart formations, candlestick patterns, and other visual chart characteristics that can be difficult to implement in automated trading systems. In addition, defining major support and resistance levels can be considered a subjective endeavor, which depends on the tools traders use for their determination.This means that trading setups are largely based on traders’ perception of market conditions.
In most cases, traders have a certain set of trading filters, obtained from analyzing previous asset performance and personal market observations. It can be said that learning about new chart formations or other market conditions expands your set of trading filters. The more trading filters you have, the more potential trading setups you can detect.
Defining Trading Triggers
An important consideration is to choose a number of trading filters to validate entry triggers. This can be described as a set of requirements, which is based on a trader’s risk management approach. If traders find themselves naturally too conservative or aggressive, it means they may have issues with their risk-to-reward ratio.
For example, let’s say you spot a strong bearish divergence on the chart. Is this enough for you to immediately go short? Will you try to uncover bearish divergence using other oscillators as well? If you see a potential formation of the trend reversal candlestick pattern that may be considered an additional confirmation of a bearish divergence signal, will you wait when this pattern completes, or ignore it? Will you check another 50+ indicators in addition to bearish divergence to make sure that a trend approaches its end?
Additional confirmations may help avoid fakeouts and false trading setups. But too conservative traders who have numerous levels of confirmation (a long list of required trading filters combined), may end up missing trades or losing a major part of the trading potential. Conversely, aggressive traders may jump into the market once spotting any trading filter. This could frequently result in losing trades. Thus, traders may need to find a balance between the number of confirmations and the risk management approach, to form entry triggers with high potential.
In order to avoid missing trades, traders who use automated trading systems should leave a certain degree of freedom in their trading plan. Too many required filters may create statistically improbable trading setups. At the same time, if traders chase “perfect” trading setups that show “100% positive trades” during backtesting, they may eventually face trading plans that are good on paper but perform poorly on real markets.
Placing Stop Loss
Having a balanced trading setup and the right conditions for entry might not be enough to produce a “secure” trade. It is recommended to have an opportunity to exit the trade in case of unexpected or unfavorable price movements. To manage risk in a trade, traders may place a stop loss order. For long positions, stop losses can be placed slightly below a recent low, while for a short trade, it can be placed around a recent swing high. Levels for placing stop loss orders may differ depending on asset volatility, market conditions, and sets of trading filters.
Once you know the entry and stop loss price, you can calculate the position size for the trade. If the price is moving in the anticipated direction, stop losses can be moved manually or by using trailing stop losses based on the percentage difference from the current price. Moving stop losses can help traders save a positive trade even if unexpected price movement occurs some time after entering the market.
Determining Profit-taking Levels
Let’s say you have considered current market conditions to be favorable, as well as defined an entry point and the stop loss level. The next step is evaluating trade potential. If opening a trade is like crossing the road, then you should know when you eventually cross it.
A price target is not just some randomly chosen level, but a measurable unit. For example, many chart formations provide generally accepted price targets based on the size of a completed pattern. Trend channels may show where the price tends to reverse. Traders can use this information to “ride the trend”, buying near the lower trend line and setting price targets near the upper line, and vice versa.
If you want to define a potential price target, you might want to pay attention to your set of trading filters. Assessing momentum indicators and volume along the price movement may provide additional hints on whether or not the price target can be achieved. Once the price reaches a profit-taking level, traders may either exit the market or reassess current market conditions to recognize potential entry triggers.
Entry triggers tell traders that it may be the time to act, but conditions required for entry triggers may vary depending on the trader’s strategy and risk-to-reward tolerance. Set a stop loss and price target to determine whether or not the reward outweighs the risk. If it does, then you may consider a trade. If it doesn’t, then you may look for a better opportunity.
Following the above-mentioned steps to perform a trade can be tedious when a trader doesn’t have a specified strategy. But once traders know their strategy, it may take a few minutes or even seconds to run through the entire set of trading filters and define setups that have trading potential.