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3 Essential Trade Components

Most of us go through a similar learning cycle, the goal of this post is to share a few game changing concepts I learned when I was starting to trade.

Each of these things is a MUST DEFINE BEFORE ENTERING any trade. From this point forward, make a commitment to yourself to implement each of these.

1. Risk control target. This is where we predetermine where we intend to exit a trade. There’s a wide array of research that goes into this, based on the product, strategy, etc. If you’re used to delta 1 products, and like to use things like support and resistance to craft your exits, that can still work but remember that options are tricky products and things like the passage of time or volatility can dramatically impact a positions PnL, so don’t forget to consider that. However, ALWAYS determine where you’ll exit every, single position BEFORE it goes on. This short circuits the common behavior to let losers run (disposition effect).

2. Profit target. This is the funner scenario but also vital. Another trait of traders is to take winning trades down prematurely (disposition effect also), and despite the bs you might’ve heard elsewhere, you can most certainly go bankrupt taking small profits. Each trade we expose ourselves to risk, if the reward doesn’t compensate for the risk that every single trader will eventually realize, it’s a problem. Think through the expectancy of your strategy. Every single position needs to have a concept of profit taking, BEFORE we enter.

3. A written out thesis. What is the trade designed to do, what do we expect it to do, how do we quantify if it’s doing what we want and most importantly, how do we know when we’re wrong. This does 2 things: makes us accountable and accept responsibility for what happens; allows us to analyze our analysis and refine. Again, to be completed before our trade is on.

Notice the emphasis on determining before entry. This is to permit a thorough, unobstructed thought process that enables optimal decision making. When a trade is on, we have a lot of other things going on. Until we’ve truly developed our trading skillset, waiting until the trade is on leads to mistakes.

Even once we’ve become profitable traders, waiting until it’s on leads to missing important details, inconsistency in execution, etc.

Remember, we can give ourselves room to analyze and react to the specific circumstances, but we need to maintain controls and structure to bound the range of possibilities.

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