We have covered all the Long Term and Short Term variables that go into the Trade Selection Tool as an input to drive the decision making process for Trade Selection.
This post will delve deep into how the Tool calculates an overall score that leads to an objective decision to select or leave a trade aside. This is one of the most critical parts of the Trading System that makes all the difference in determining your success or failure as a trader.
One of the most important reasons why Trade Selection is important is that it greatly helps in preserving your capital. Good trades mostly lead to profit and add to your capital whereas bad trades do exactly the opposite. Apart from preserving capital, do not forget the psychological impact of making good trades. They add to your confidence and your conviction which matters a great deal in taking good decisions. So it is a virtuous cycle. Bad trades undermine your confidence and fill you with self doubt, particularly one that results in a big loss.
Adhering to the Trade Selection process (part of Trade Preparation) requires discipline and character. You need to work on it to make it stronger every day. We will talk about it in the next section when we discuss the Trading Psychology but know that these two are deeply connected.
As this is such an important concept, we think it would be preferable to explain it with the help of some practical examples. Let us start with presenting the input tables that are populated as the Trade Preparation window starts @ 4PM.
Input Table 1 - Long Term Trend
As on date : 26th April @ 4 PM (can be populated earlier than 4 PM as the it should not change substantially unless there is a big move)
Commodity/ Index | Weekly Trend | Daily Trend |
DJIA | Big Hammer at Support - Bullish | |
Nasdaq | Big Green after Gap Down - Bullish | |
Copper | Strong Uptrend - Bullish | Strong Uptrend - Bullish |
Zinc | Strong Breakout - Bullish | Triple Top Breakout - Bullish |
Aluminium | Strong Breakout - Bullish | Sell Failure (Range breakdown) - Bullish |
Crude | Piercing Pattern - Bullish | Big Green Breakout above Resistance - Bullish |
Natural Gas | Sideways - Neutral | Big Red (False Breakout above Triple Top) - Bearish |
(Table 1.1 - Input Table for Long Term Trend)
Input Table 2 - Setups forming on 2H chart on C4
As on date : 26th April @ 5 PM (to be populated initially around 4:30 PM, then checked again @ 4:50 PM if the setup still holds and make changes if required).
The two identifiable setups on C4 are for
Aluminium - Snake Buy - Bullish and
Natural Gas - 3 Lower Low - Bearish
Both the charts are provided below for your reference.
(Fig 1.1 - Snake Buy Bullish Setup on C4 on Aluminium)
(Fig 1.2 - 3 Lower Low Bearish Setup on C4 on Natural Gas)
As the setups are identified, the following Input Table 2 is populated for the Setup and the Setup Strength (from Win Ratio and Profit / Lot).
Next step is to populate for other variables only if the Setup Strength is tradable (WR>70% and Profit / Lot - Average to High). In the above example, we complete the exercise only for Aluminium as the Setup Strength is tradable. The one on Natural Gas does not have tradable Setup Strength.
Commodity | Setup | Setup Strength (WR + Pr/Lot) | 2H Pattern | S&R | Setup for Sis Comm |
Copper | No Setup | ||||
Zinc | No Setup | ||||
Aluminium | Snake Buy - Bullish | 73% - High | None - Sideways | Middle of Narrow Range | Both Neutral |
Crude | No Setup | ||||
Natural Gas | 3LL - Bearish | 67% - Low |
(Table 1.2 - Input Table for Setups and related Short Term Variables)
Now that the two input tables are populated, we can feed the values to the Trade Selection Tool and use the Scoring Rules to calculate an objective score for each tradable setup. This would lead us to the final decision of taking or leaving the trade.
Trade Selection Tool - It is a spreadsheet based table and has a section each for Long Term and Short Term variables. These sections are populated based on the recording from the input tables as above, in the following way:
Long Term Variables (LTV) from Table 1 - All relate to Longer Term Trend (Daily/ Weekly)
For Bullish Trend : B (Buy)
For Bearish Trend : S (Sell)
For Sideways or Unclear : N (Neutral)
Commodity | Wkly Trnd | Daily Trnd | Sis Comm Daily Trnd | US Indices Daily Trnd | LTV Score |
Copper | B | B | B | B | 4 B's |
Zinc | B | B | B | B | 4 B's |
Aluminium | B | B | B | B | 4 B's |
Crude | B | B | NA | B | 3 B's |
N Gas | N | S | NA | NA* | 1B, 1S |
(Table 1.3 - Trade Selection Tool - Section for LTV ) (* The Long Term Trend on US Indices is not applicable for Natural Gas at it is not seen to be impacted by a Bullish or Bearish Trend)
Short Term Variables (STV) from Table 2 - All are specific to the Setup
For Favourable : 1 (Strong Confirmation of Setup)
For Unfavourable : (-)1 (Against the Setup)
For Neutral or Unclear : 0 (Neutral to the setup or Unclear)
Setup Strength | 2H Pattern | S&R | Sis Comm 2H Patrn | STV Score | |
Copper | |||||
Zinc | |||||
Aluminium | 1 | 0 | 0 | 0 | 1 |
Crude | NA | ||||
N Gas | NA |
(Table 1.4 - Trade Selection Tool - Section for STV )
Once the scores are calculated as above, the Trade Selection is based on the following rules :
(Table 1.5 - Scoring Rules for Trade Selection)
So in this example, the score for the setup for Long Trade in Aluminium is:
LTV - 4 B's
STV - 1
While LTV score meets the criteria, STV score is only 1 (Minimum 2 required). Hence there is no trade.
Lets take another example from an earlier date, April 5. The identifiable setup that forms on C5 on Crude is Bullish Engulfing (figure below).
(Fig 1.3 - Bullish Engulfing Bullish Setup on C5 on Crude)
The LTV and STV sections of the Trade Selection Table are provided below :
Commodity | Wkly Trnd | Daily Trnd | Sis Comm Daily Trnd | US Indices Daily Trnd | LTV Score |
Crude | B | B | NA | S | 2 B's |
Commodity | Setup Strength | 2H Pattern | S&R | Sis Comm 2H Patrn | STV Score |
Crude | 1 ( WR 93%) | 1 (Sell Failure) | 1 (no nearby resistance) | NA | 3 |
(Table 1.6 - Trade Selection Tool for Crude)
This meets the minimum criteria for the Long Trade in Crude (LTV - Min 2 B's and STV -Min 2 required). Hence the trade is taken.
3rd Example : The identifiable setup that forms on C5 on Natural Gas on 15th of March is a Bearish Engulfing and Big Red below Support, both bearish setups (figure below). Whenever we see 2 or more setups forming in the same direction, the probability of success of the trade increases.
(Fig 1.4 - Bearish Engulfing and Big Red below Support - 2 Bearish Setups on C5 on Natural Gas)
The LTV and STV sections of the Trade Selection Table are provided below :ain Com
Commodity | Wkly Trnd | Daily Trnd | Sis Comm Daily Trnd | US Indices Daily Trnd | LTV Score |
Nat Gas | S | S | NA | NA | 2 S's |
Commodity | Setup Strength | 2H Pattern | S&R | Sis Comm 2H Patrn | STV Score |
Nat Gas | 1 ( WR 76% and 74%) | 0 (None) | 1 (no nearby support) | NA | 2 |
(Table 1.7 - Trade Selection Tool for Nat Gas)
modi
This meets the minimum criteria for the Short Trade in Nat Gas (LTV - Min 2 S's and STV -Min 2 required). Hence the trade is taken. y
To conclude, Trade Selection considering the above variables is designed to pick only the best trades with the least amount of risk. The variables chosen by us as above ensure that all major factors that impact a trade are carefully considered and baked into the decision making process of taking or leaving aside a trade. Nothing gets left out inadvertently in the heat of the moment.
The Tool is designed to instil discipline in you in selecting a trade objectively instead of running after every trade that 'looks' good on the screen. If adhered to diligently and religiously, it will certainly become instrumental to your long term survival and profitability in the market.
With this, we have concluded our discussion on Trade Selection, the third pillar of our Trading System. Please click on "Next Post" to navigate to an Introduction to Trading Psychology, the fourth and last pillar of our Trading System.
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