3 Questions to Ask Before Any FX Trade

02/18/2015 8:00 am EST

Focus: FOREX

Raghee Horner

Futures & Forex Analyst, SimplerTrading

Long before planning elements like entry and stop placement, currency expert Raghee Horner explains other critical considerations that must come prior to trade entry.

Many times trading gets boiled down to the entry, the profit target, and stop loss. Sure, these are important-in fact, they are the building blocks of a trading plan-but they aren't all that you need to know, and quite frankly, they are the last three things you need to know. So then, what are the first three things that you must do before placing a forex trade?

1) What's on the Economic Calendar?

Before the trade-any trade-I make sure I am keenly aware of the economic calendar and dominant headlines not just for that day, but what happened while I was away from my trading computer. For economic releases, that means looking at the week in its entirety with particular emphasis on the session that proceeded, the current session, and what the market could be looking ahead to.

For the headlines, I will look to sites like Forex Factory and Bloomberg to see what traders are reacting to and therefore discounting into the market. This allows me to gauge the potential risk of the session, when volatility is most likely to increase, and what time frames I will consider in this environment.

What Is the Directional Bias?

Time frame selection is determined in great part by identifying the directional bias in the market. Whatever symbol you are trading, the daily time frame is the first consideration, and not necessarily for a trade, but to know what the dominant psychology of the market is. This is done by using my 34EMA Wave and GRaB candles.

By understanding the sentiment, momentum, and trend in the markets, you are actually identifying whether it's the bulls, bears, or no one who's in the driver seat. Trending daily time frames have what I call a "trending directional bias," and that is the best type of market to focus your efforts on because there is a clear, dominant psychology.

You want someone behind the wheel; you really shouldn't care if it's a bull or bear. If there is a trending directional bias, enter a trade where the trend is valid across all intraday time frames, and of course, on the daily itself. It would, however, be best to limit countertrend entries to only short-term time frames like the five-, 15-, and 30-minute. It is always the path of least resistance to follow the trend, and therefore, better to trade a symbol that has a trend on the daily.

What Is my Cost Per Trade?

Another aspect of a trade is cost and pip movement. Many traders do not factor in the cost for a trade before they enter in terms of understanding the spread, and this can change slightly for each of the major sessions. Cost per trade can also include rollover, if applicable to your trading account and depending upon how long you hold the position.

Longer-term time frames are not impacted as greatly by a short-term time entry and may be reconsidered if the pip movement doesn't justify taking the trade because of the spread. Pip movement ranges are part of that same discussion.

Each market has a rhythm of its own whether we're talking about a stock, futures contract, or forex pair. For forex, I know exactly what the expected pip movement range is for each pair I trade during each hour of the day. This is a must.

Consider this: If a trader were to reference the hours between 8:00 am and noon EST and use that as a gauge for pip movement for 8:00 pm to midnight, their expectations would be severely off the mark since the pip movement between the European, UK, and US overlap can be (sometimes) twice that of the Asian session.

These first three things are the most influential because they determine the following:

  • Which pair you will even consider for a trade
  • Which direction you will enter the trade
  • Which time frame to focus on
  • Which strategy to use
  • How much risk tolerance you will need

The last step of a trade-and the last thing you need to consider before the entry-is your risk/reward ratio, but all too often this becomes the point at which traders begin their trading plan, and that's why so many traders struggle. Unfortunately, it's because they don't understand the larger forces at work: the risk environment, the economic environment, and the dominant psychology of the symbol they are trading.

See also: Always Consider Risk Before Trading

By Raghee Horner of DailyForexTradingEdge.com and IBFX.com

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