How to Make a Trading Decision

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:

1. Define your goals

2. Do your research

3. Develop a strategy

4. Follow your plan

5. 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.

• 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.

• 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.

• 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:

• 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.

• 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.

• 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.

• 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.

• 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.

• 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.

• 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:

• 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.

• 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.

• 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. Developing a trading mindset is essential for achieving long-term success in the financial markets.

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:

• 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.

• 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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