Every great trader knows that success in trading requires consistency, discipline, and a well-thought out plan. Before you put on ANY trade you need to be sure, that at the very least, you have the following three things—an entry point, a stop/loss level, and a logical price target. There is no justification for not having a trading plan.
To illustrate with a simple example, I have provided the below chart of Lam Research (LRCX). This is the daily timeframe for the equity after the market closed this past Friday, 2/1. It was a name that had been on my watchlist and it had some very basic chart patterns that appeared to be forming.
You can see from my notes on the chart that I was observing the bull flag pattern that had been forming for several days now. After the big candle (defined by the arrow), where the stock broke out on 1/25/13, it was followed by several more days of sideways action. LRCX never broke above the closing highs of $41.84 from 1/25, but it was showing some technical strength, as it never gave back much of those gains. This was a promising sign, and it immediately triggered a possible entry point—I would look for a sustained move over $41.84.
The next step was to identify a logical price target. If you review the embedded link, you will learn that a simple method for measuring an anticipated move, is to take the difference between the open and close on the “flag pole” (in this case, the long candle on 1/25), and estimate the next breakout higher. LRCX opened at $39.97 and closed at $41.84 that day—a gain of $0.87. A move of $0.87 above the highs would put the initial price target at $42.71. Note emphasis of the word initial, as I firmly believe that you should take partial profits when the market makes money available to you. Part of the trick is to still leave room for further upside. Below is the chart on the following day of trading—2/4/13.
Notice the arrow that is now focusing on the breakout from the previous trading range. On 2/4, LRCX traded as high as $42.76, just slightly surpassing the measured move to $42.71.
Now comes the most important part of the trade—managing your position should the trade reverse against you. If you look closely at the candle from 1/31, you can see that the close was $41.14. It could be argued that any move below $41.14 (you could lower your threshold to $41) would indicate that the equity was approaching a new area of buyers/sellers and could break even lower. For the purposes of this writing, let’s say that a trader initiated a position after a move (and subsequent hold) above $41.84—their intraday analysis and trade drivers lead them to believe that LRCX was going higher. Unfortunately, this was a “failed breakout” and it quickly shot back down and approached the $41 level. At what point do you bail on the trade? What is your stop-loss level? In my opinion, a good level (based on recent price action) would be anywhere below $41.14. The skill lies in not being too “premature” with your exit and therefore placing an order that will get you out when your position is losing money. The best traders know when to admit that their initial trade drivers were wrong and they therefore do not hesitate to admit that the trade is broken. This is undoubtedly one of the most challenging aspects of trading.
My simple advice for you is to create a checklist of things to go over before you make each and every trade. Having a plan will go a long way in this competitive environment, and you shouldn’t be putting on a trade unless you have uncovered the basics—an entry point, an exit point, and a target price. As the cliché saying goes: “If you fail to plan then you plan to fail”—so make yourself less susceptible to “failure” by going through all the right steps.