Be A Better Trader. Part 5. Parts of a Trade

This is the continuation of the series “How to be a better trader?”. Click here to start from Part 1

The most basic question — What is a trade?

Buying or selling something is NOT a trade.

A trade is not an up/ down decision. It is an execution plan with many parts. You need this plan before you trade. And you must stick to the plan. Let us go through the parts of a trade.

Think of these as a mental model to think, and as a checklist to not miss anything. Write these down every evening for your next day’s trades. Make it a habit. If you do that, there will be a significant improvement in the quality of your decisions.

The parts of a trade are:

1. Your Market View
2. Reasons for your market view
3. Entry
4. Exit
5. Stop Loss
6. Time Frame
7. Instrument + Expiry
8. Bet Size

Write these down. Writing brings clarity. Writing brings discipline.

1. Your Market View

Simple. A view looks like “NIFTY is going to go up”. Up or down is where the view starts. It could also be that it is going nowhere.

2. The Reasons for your Market View

There are two points to remember.

One, re-evaluate your original reasons for the trade when something changes. Like your reason for NIFTY to go up was that RBI will not hike interest rates. But if a high inflation number comes, your reason might not be as strong as it was. Writing it down will remind you this, and help you re-think.

Two, one reason is not enough. You need many reasons for a trade.

Example: Stock X will go from 100 to 110 because:

1. There is 200 DMA at 100
2. The last time it went below 100, there was a huge bullish hammer candle, with high volumes
3. 100 happens to be the bottom of a channel
4. Results came out lower than expectations, which is bad news. But the stock did not go down. This means the stock is strong and people are not selling it
5. There are no events in the next few days.

Long story short — you need many strong reasons for a trade. At least 3. Do not trade on a single reason, wait for the trades with many reasons. Patience is a virtue.

3. Entry

Just because a stock is going up or down, you do not enter it. You wait for the right entry point. Let us say NIFTY is at 10250 and you think it is going up. Doesn’t mean you jump into the trade. You look, and see a 200 DMA support at 10200. You wait till it comes near 10200, and enter there. Yes, sometimes, you might miss the entry, and miss the trade. Don’t worry, there is always the next trade.

Your entry point should be near a big support if you are buying or a big resistance if you are selling. Or you enter because of a clear signal, like a candlestick pattern.

4. Exit

Your target has to be far enough from your entry point to make enough money. One of the beginner mistakes is setting targets too close to entry, which means trades end up being small wins. You need big wins and small losses. Not the other way around.

Much like entry, your exit has to be close to a big support or resistance or backed by a big exit signal.

One last point — exit need not be a number. It could be a situation. Like you have BANK NIFTY futures long, and there is going to be an announcement today. Now the situation has changed. You need to re-analyze the situation. So you exit with whatever P&L you have to avoid being in something which you do not understand.

5. Stop Loss

We will cover this in detail in the next post. For now, it is important to know that stop loss the most important thing in trading.

6. Time Frame

Your trade has a time frame. Because the world changes with time. What you thought today about bank nifty will not be true after the next RBI policy. So have a time frame marked by events in your mind when you are trading.

7. Instrument + Expiry

Next comes the instrument to bet. This is crucial. Let us say you are having a bullish view. Buy stocks, right? No? How about futures? No! Here are some ideas:

1. Buy Stock
2. Buy Future
3. Buy Call — Near month expiry — ITM/ ATM/ OTM
4. Buy Call — Far Month Expiry — ITM/ ATM/ OTM
5. Sell Put — Near month expiry — ITM/ ATM/ OTM
6. Sell Put — Far Month Expiry — ITM/ ATM/ OTM

We can help you get this part right with trade.sensibull.com/options. Do try it!

8. Bet Size
The legendary trader often referred to in our posts says, “if you have trouble going to sleep with a trade open, that is not the size you should be trading with”. Nithin, if you are reading this, this is the last legendary quote on you 😛 If you bet more than you can lose – emotions will muddle with your decisions.

The thumb rules in this department are:

Ideally, do not bet more than 5% of your capital on buying options. Better still, stay away from buying options.

Trade with a constant number of lots. Like 1 lot future, or 2 lots options. Keep this constant, even when you have made money and your account size has increased. Increase this once in 3 or 6 months, only after you get comfortable with this size.

Our suggested bet sizes are:
– 1 NIFTY future for every 1 L margin in your account
– 1 Bank NIFTY future for every 1.5 L
– 1 Single Stock future for every 2 L. Some stocks have smaller lots, you can trade them with smaller margins.

Now we have all the parts of your trade sorted. Try writing these things down before your trading day. One important point to remember — Give enough thought to which instrument you will use to execute your view. Futures? Options? Calls? Puts? This makes a lot of difference. Think it through.

One last point — It is okay if your trading plan reads — No trade for tomorrow, the market looks tricky. This is one of the best trading decisions almost all the time. Not having a position is a position.

Thanks for reading this long post.

Continue to Part 6

This post is part of an initiative by Sensibull — India’s first Option trading platform to educate retail investors on the nuances of Options Trading and make them profitable

Do not forget to check out the Options Strategy Generator which tells you the best Options to trade for your view here: trade.sensibull.com/options.

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