How to Make a Trading Decision
To make a decision as a trader, you should follow five steps:
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Define Goals: Look at short and long-term goals, assessing risk-reward tolerance
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Do Research: Conduct technical, fundamental, and market analysis on assets
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Develop Strategy: Outline a trading plan, whether its day trading or swing trading
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Follow Plan: Adhere to strategy, practicing emotional discipline
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Evaluate Progress: Regularly assess progress and adjust plan accordingly
Making decisions as a trader can be tough. With every trade you enter, you are forced to wonder what the outcome will be, whether the investment is worthwhile, and how well your chosen asset will perform. So, what can you, as a trader, do to make sure that you’re making the right trading decision? Traders Union is here to help you answer that question. In this article, we’ll be providing a simple-to-follow, step-by-step guide that breaks down the decision-making process into five steps.
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How do day traders make decisions?
To make decisions, day traders first set out their short-term and long-term goals, defining their own risk-reward ratio. They then conduct research, assessing an asset’s technical data and fundamentals. They then decide whether a trading decision aligns with their overall strategy or set out a new strategy for an individual trade. Lastly, they continuously evaluate their positions based on new market information and adjust accordingly.
5 steps to make a trading decision
Trading decisions, like business decisions, should be made with profit maximization in mind. Traders should only enter trades they believe will yield positive returns. A well-prepared trader, with a clear trade plan, can better handle market changes and economic environments.
There are some simple steps that traders can take so that making trading decisions does not seem so daunting. By compartmentalizing the decision-making process into five steps, traders can adopt a systemic approach for each trading choice and follow it each time as part of a wider trading strategy.
The five steps we will look at are:
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Define your goals
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Do your research
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Develop a strategy
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Follow your plan
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Evaluate your progress
Let’s take a closer look at each step in the decision-making process.
Step 1: Define your goals
The first step in making a trading decision should be to consider your overall trading goals, whether they be short-term or long-term. You should also consider your appetite for risk versus reward, whether that means setting an individual ratio for the individual trade or aligning it with your pre-established ratio.
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Short-Term Goals: If the trade is meant to be a short-term one, consider how much income it is likely to generate in a short amount of time. Are you trying to preserve capital for use in other trades? If so, consider a more conservative trade approach. If you’re trying to capitalize on specific market events or news, think about whether your trade is timely enough to do so.
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Long-Term Goals: If you are trading an asset with long-term goals in mind, focus on solid, fundamentally sound investments with the potential for sustained growth over long periods of time. Decide how long you will keep the position open- are you hoping to see returns in a year, planning for retirement, or somewhere in between? Long-term trades often prioritize risk management to preserve capital, so take this into account before trading.
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Risk-Reward Ratio: Assess how much risk you are willing to take for each trade and compare it with the potential reward that a trade could generate for you. If you’re trading short-term, you could take on more risk for potentially stronger gains, whereas long-term investors may prefer lower-risk strategies to safeguard investments. You should understand the market conditions and economic factors that align with your risk and reward preferences, which involves conducting thorough research on each asset, which we will look at next.
Step 2: Do your research
Conducting thorough research into each asset you consider investing in is a key component in becoming a successful trader. The more you know about an asset, the more likely you are able to somewhat accurately predict how it will perform, and therefore whether it's worth investing in. When researching an asset, assess this information to help you decide on a trade:
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Fundamental Analysis: For stocks, examine the company's financial statements, including balance sheets, income statements, and cash flow statements. Analyze recent earnings reports and the company's profit margins and assess revenue and sales trends over time. For other assets such as forex, assess relevant economic indicators that may impact the asset, such as GDP growth, employment rates, and inflation.
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Industry Analysis (Stocks): Try to understand the broader industry trends and how this specific asset fits into the sector. Analyze the competitive landscape and the company's position within it.
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Market Analysis: Identify any broader market trends that may exist, and understand how the asset fits into the market. Evaluate overall market sentiment, including factors like market news, geopolitical events, and economic conditions. For example, if researching a cryptocurrency, consider whether the overall market is bullish or bearish.
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Technical Analysis: Every financial asset in trading has endless tools that allow you to analyze data and find trends. Use technical analysis to analyze price charts, identify trends, support and resistance levels, and potential entry points. You can also utilize technical indicators and oscillators for additional insights into price movements.
Step 3: Develop a strategy
The type of trading you are engaging in will ultimately determine whether or not a trade should be entered into or exited. Whether you are day trading, swing trading, or scalping, or any other type of trading, significantly influences the considerations when selecting an asset to trade. Each strategy has its own characteristics, so you should align your choices with the specific requirements of your preferred strategy.
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Day Trading: If you are day trading, you’re aiming to complete all trades within a single trading day, avoiding overnight exposure, and should therefore prioritize highly liquid assets with significant intraday price movements. You should also seek out assets with high volatility to capitalize on short-term price fluctuations.
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Swing Trading: As a swing trader, you hold positions for a few days to several weeks, capturing gains on short to medium-term trends. Look for assets with identifiable trends and sufficient volatility for swing movements. You can use technical analysis to identify entry and exit points, and fundamental analysis for identifying longer-term trends.
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Scalping: Scalpers look to make numerous small trades throughout the day and hold positions for very short amounts of time to make small incremental profits, so if scalping, look for the most liquid assets with tight bid-ask spreads to facilitate quick executions. Use short timespan tick charts for precise entry and exit points in response to very short-term price movements.
There are plenty of different trading strategies out there, each requiring its own specific and carefully implemented approach. We looked at just three here, but you can learn more about simple and effective trading strategies here: Simple Forex Trading Strategies for Beginners.
Step 4: Follow your plan
Once you have defined your goals, conducted research, and set out a trading strategy, it’s time to make your trade. Once you’ve entered the trade, the next difficult part is to stick to the plan you set out for this particular trade. Adhering to your plan ensures consistency and a structured approach to trading. Try to implement these aspects into following your plan:
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Emotional Detachment: Emotions, such as fear and greed, can cloud judgment and lead to impulsive decisions. Emotional detachment is crucial for making rational, well-thought-out choices and sticking to them. If a trade is not going as planned, avoid succumbing to panic or frustration. Stay focused on your predetermined exit strategy and avoid making emotionally charged decisions.
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Patience & Consistency: Resist the temptation to deviate from your plan due to impatience. Markets can be unpredictable, and not every trade will be a winner. Patience and consistency contribute to long-term success by allowing your strategies to play out over time. Be disciplined in your trading strategy.
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Professional Mindset: Treat trading as a professional endeavor, employing a level-headed, disciplined mindset. Approach each trade as if you were a seasoned trader, embracing a mindset focused on continuous improvement and adherence to a well-defined plan.
For a more detailed guide on developing and maintaining a trading plan, see Traders Union’s article: Trading Plan Guide in 7 Steps.
Step 5: Evaluate your progress
Once you’ve entered a trade, and even after you’ve closed it, it’s important to foster continuous growth by regularly tracking your results. You should also be flexible in your response to market movements, making adjustments when needed if conditions change. To continue your trading growth journey, try to:
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Continuously Adapt: Regularly evaluate your plan's effectiveness in the context of each trade you make, and make necessary changes based on real-time feedback. Try to avoid making changes impulsively and instead do so through a thorough analysis of market dynamics and your own trading performance.
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Learn from Mistakes: Mistakes are inevitably going to happen when trading. To be a disciplined trader, you should acknowledge and learn from errors rather than allow them to disrupt your overall strategy. Don’t dwell on losses, use them as learning opportunities.
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Conclusion
Making trading decisions is a complex process that requires traders to have a deep understanding of the market, the factors that influence its movement, and how to analyze information. To make trading decisions as a professional:
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Learn the fundamentals of trading.
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Develop a trading strategy.
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Practice on a demo account.
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Track your results.
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Don't be emotional.
Making trading decisions is a process that takes time and effort. However, if you persevere, you can increase your chances of success in the financial markets.
Glossary for novice traders
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Broker
A broker is a legal entity or individual that performs as an intermediary when making trades in the financial markets. Private investors cannot trade without a broker, since only brokers can execute trades on the exchanges.
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Trading
Trading involves the act of buying and selling financial assets like stocks, currencies, or commodities with the intention of profiting from market price fluctuations. Traders employ various strategies, analysis techniques, and risk management practices to make informed decisions and optimize their chances of success in the financial markets.
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Scalping
Scalping in trading is a strategy where traders aim to make quick, small profits by executing numerous short-term trades within seconds or minutes, capitalizing on minor price fluctuations.
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Forex Trading
Forex trading, short for foreign exchange trading, is the practice of buying and selling currencies in the global foreign exchange market with the aim of profiting from fluctuations in exchange rates. Traders speculate on whether one currency will rise or fall in value relative to another currency and make trading decisions accordingly.
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Day trading
Day trading involves buying and selling financial assets within the same trading day, with the goal of profiting from short-term price fluctuations, and positions are typically not held overnight.
Team that worked on the article
Jason Law is a freelance writer and journalist and a Traders Union website contributor. While his main areas of expertise are currently finance and investing, he’s also a generalist writer covering news, current events, and travel.
Jason’s experience includes being an editor for South24 News and writing for the Vietnam Times newspaper. He is also an avid investor and an active stock and cryptocurrency trader with several years of experience.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).