Before opening a trade, there are several important decisions to be made – a game plan needs to be mapped out.
This game plan is a set of rules which, when made under calm and relaxed conditions, will help you to navigate the confusion and noise which is usually experienced once a position is taken.
- What direction is the market moving?
- Where to enter?
- Where to exit?
- How much capital to invest?
- What happens if things go wrong?
At XATS, we use our proprietary trading system to make these decisions. This cuts out any emotional biases and human error, whilst maintaining a consistent approach to all decisions.
What direction is the market moving?
This is defined as the market trend. It can go up, down or sideways, and we use our proprietary Tension Indicator to map it. A rising Tension Indicator describes a bullish trend whilst a falling Tension Indicator describes a bearish trend. A flat Tension Indicator describes a flat trend – consolidating market.
To confirm a trend, we use a classical moving average crossover. This moving average is actually an 8-period weighted moving average, (8WMA).
When the Tension Indicator crosses above the 8WMA, this signals what we believe to be the beginning to a bullish trend. A ‘buy’ signal is then generated.
When the Tension Indicator crosses below the 8WMA, this signals what we believe to be the beginning to a bearish. A ‘sell’ signal is then generated.
A flat Tension Indicator which crosses the 8WMA numerous times, describes a consolidating/flat market.
Where to enter?
When a signal is generated we enter the market at the close of that session.
For example, if a “buy” signal is generated today on a daily chart, we enter the market today.
If a “buy” signal is generated today on the weekly chart, we enter at the weekly close.
Where to exit?
We adopt 2 strategies to closing a position.
The first is when the Tension Indicator changes direction. For example, a bullish/rising Tension Indicator breaks below the 8WMA, or a bearish/falling Tension Indicator breaks above the 8WMA.
The second reason to exit a trade is when the stop loss is reached. This does not mean the trend has changed, but rather the market is becoming a little more volatile. We advise against ignoring stops, even if the market looks to be extending the trend.
How much capital to invest?
This is a difficult question to answer, as each investor has their individual risk, or tolerance, levels. A good rule of thumb is to use 2% of the available capital per entry. Whilst it doesn’t sound like a lot, if there are 10 positions open, then the portfolio has 20% invested.
What happens if things go wrong?
This question is of paramount importance – even more so than the favourites, “How much can I make?” or “How much do I need to invest?”
If there is no exit plan in place, then losses can increase very quickly. A case in point is the Nick Leeson story from several years back. He did not close his initial position when the market moved against him. Instead, he believed that it was just a small correction, and that the market would turn higher once again. He then increased his position, and did so as the market continued to fall. The end story is that he lost all of his trading capital – not to mention the company. If he had closed his position when the market traded below his stop loss, then the outcome would probably have been different.
A stop loss is of paramount importance, and we recommend investors ALWAYS have this in place before opening a position. Additionally, NEVER SECOND GUESS the stop. If it is activated, the position is closed.