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Trade entries
The stockbroker Gordon Gekko said – quoted several times – in the
US-American film “Wall
Street”: "The decisive point is that greed – unfortunately there is
no better word for it – is good.
Greed is right, greed works."1
But what is greed and how does it influence us in our daily
trading?
FOMO (The Fear Of Missing Out) is a problem that every trader has
experienced at least once.
We have prepared our trading plan and now the chart looks almost as
if our trade is about to
start, but the last criterion has not yet been fully met. But what
if the price suddenly moves
sharply and we miss the trade? All the effort, planning and waiting
would then be worthless and
we also missed our possible profits. Should we risk it now and just
start early, the trade is almost
confirmed and it looks like it will happen soon anyway?
Every trader regularly fights such or similar scenarios and his/her
own greed-driven demons. It
does not seem like a big mistake per Se, because most of the
signals are almost confirmed. But
the word almost makes all the decisive difference in this context –
and as most traders would
confirm, such trades almost always and rightly end in a loss.
However, losing is not the biggest problem in this case because a
trader regularly breaks his/her
rules, quickly becomes inconsistent and the results can no longer
be interpreted effectively. If a
trader constantly changes his/her rules or enters a trade
completely without observing any rules,
the subsequent trade analysis is of no use. During the follow-up of
trades, no conclusions can
then be drawn as to where trading is already running satisfactorily
and where some catching up
still needs to be done. Inconsistent results must therefore be
avoided since this does not allow
for further development.
If you want to become a professional trader, you must be able to
control your greed for entry
and the FOMO mechanisms. Unfortunately, there are no secret
shortcuts or tricks for this. The
only way to achieve the goal is to continue improving
yourself.
1 https://en.wikipedia.org/wiki/Gordon_Gekko
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1. The candlestick closure filter
A good tip to deal with the problems related to trade entries is
the so-called candlestick closure
filter. The rule says: do not look at the charts during the
candlestick period. You are only allowed
to analyse the trades and the price when the candlestick closes.
Those who use the 1-hour chart
for trading should only look at their charts every hour; those, who
choose the 4-hour chart,
should only open their trading platform every four hours, and the
traders, who use the daily
chart, should look at their charts only once a day.
I have hardly met a trader for whom following this advice would not
have led to an improvement.
Although most are sceptical initially, the advantages speak for
themselves.
Many traders fall for unconfirmed breakout attempts, which then
reverse and become traps. This
is a common phenomenon that can cost inexperienced traders a lot of
money. Most traps can be
easily avoided by waiting until a candlestick is formed completely
before making a trading
decision. Naturally, you will miss a trade every now and then – but
you can also avoid a lot of
loss-making trades. Greed-driven traders are more likely to mourn
the missed profit
opportunities – but for a trader's development and emotional
well-being, avoiding losing trades
is much more important.
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2. Structure breaks – entry filter
Chart patterns usually have a clearly defined entry point. For
example, the Head-and-shoulders
formation is triggered only when the neckline is broken; the
Cup-and-handle formation signals a
trade entry when the handle is broken, and a Wedge leads to a trade
only when the price has
completed the breakout. We can also see all these points –
necklines, handles, highs and lows,
wedges – as entry filters and, together with the candlestick
closure filter, we can make our trading
extremely robust.
Thus, we should always wait until the price has completely broken
through such a structure and
also closed outside. Trade entries during the candlestick period
should be completely avoided to
establish a new level of consistency. Traders who react very
impulsively and constantly jump in
and out of trades will benefit from this method.
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During the trade: trade management
In the case of a trade that is currently in profits, we face two
problems: Firstly, the price could
reverse any second and all our unrealised profits could vanish into
thin air. Secondly, we could
possibly get much more out of our trade if the price continues to
develop favourably. This is an
internal conflict that often tortures traders. Even a good trading
plan usually fades into the
background as soon as the trader becomes aware of this problem.
However, the fear of
relinquishing profits usually wins and the majority of traders
always closes their trades too early.
This naturally leads to immense problems, because the combination
of large losses and small
profits will ruin even the best trading system. Even if a trader
manages to make more profit than
loss trades, his/her account will still move into minus if he/she
cannot maximize his/her profits.
If you suffer from this problem and constantly close your trades
too early, you can deal with it
better using the following points:
3. No baby-sitting for trades
It is a rumour that you become a better trader if you follow your
charts carefully and are always
in front of your computer. This screen-time myth is very misleading
and counter-productive,
because a trader who follows every price movement point by point
tends to be more impulsive
with his/her trades. Even the smallest movement in the opposite
direction suddenly looks like a
complete trend reversal when profits melt away. Many traders then
exit the trade impulsively,
then panic and try to chase after the price that develops
favourably. This reactive behaviour must
be avoided.
The candlestick closure filter is the best and most powerful aid
for this purpose. Less is more –
this is applicable to screen-time as well. I can recommend trying
this despite scepticism. You can
also look at the price much more objectively if you know that the
candlestick closure rule
prohibits closing the trade at present.
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4. Objective exit rules
It is said that the last objective moment is before you press the
buy or sell button. Therefore,
before entering a trade, every trader should be aware of what would
signal an early trade exit:
What does he/she expect from the price on facing the next
resistance? How deep can the
correction waves go? What happens when the price breaks the last
high? What should happen if
there is a divergence or rejection of the trade? These points also
belong to a trading plan. Those
who then start to wonder can refer to their trading plan and
validate whether a premature exit
is appropriate or whether individual fear mechanisms are trying to
gain the upper hand.
5. Do not trade your account balance
A trade should never become a function of the trading account. This
means that you need to use
your own objective exit rules for the trade management and trade
exit. It is a big mistake to see
how the trading account performs while being in a trade. It often
happens that traders want to
continue with their winning trades too long to make up for the last
loss trade. Or they close the
trade too quickly when in profit if they can already achieve their
arbitrarily set daily or weekly
profit target.
When you make a trade, you should never monitor your account
movements simultaneously. It
makes sense to keep the section in the trading platform that
displays the unrealised profits
closed. This way, impulsive and purely money-driven decisions can
be avoided.
As a swing trader, it is also possible to separate chart analysis
and trade execution completely.
Thus, the trader should use his/her broker platform only to execute
trades. Once he/she has done
this, he/she should switch to his/her neutral chart analysis
platform, where he/she only carries
out chart analyses and does not have the constant opportunity to
tamper with his/her trade.
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6. The 10-second rule
In his biography, Magnus Carlsen, one of the best chess players in
the entire world, said: “I usually
know what I am going to do after 10 seconds; the rest is
double-checking.”2 This beautifully
describes what goes inside the mind of a chess player when he
thinks about the next move for a
long time. Probably a world-class player like this has already
memorised many of the possible
chess moves in some form, but he does not rely on his instincts and
checks every possibility many
more times.
We often feel the same way when trading. We have a premonition of
what the price could do
next, because the pattern looks kind of familiar. Inexperienced
traders then quickly make the
mistake of blindly following their gut feeling and not thinking
further.
Leaning back for ten seconds and looking at the current chart
scenario can make a big difference.
The greedy inner demon can thus be controlled in a better manner
and brought to rest.
Therefore: Before making a trading decision, always take your
finger off the mouse or put your
smartphone away for a moment (depending on the technology you are
using for trading) for ten
seconds!
2
https://www.chess.com/forum/view/chess-players/magnus-carlsen-grandmaster-flash
[19.04.2018]
https://www.chess.com/forum/view/chess-players/magnus-carlsen-grandmaster-flash
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Trade exits
When it comes to dealing with profits and losses we must take a bit
more time because such
trade exit related situation can pose great challenges for a trader
if managed incorrectly. On the
other hand, a trader who knows how to effectively deal with such
scenarios can often improve
his/her edge significantly.
7. Losses
Greed influences us not only in our entry decisions, but also often
in how we handle of losses.
We quickly start wondering whether we should really close the trade
in a loss, because there is
still the possibility that the price could reverse in the right
direction. It might even be
advantageous to re-buy at the current price, because if the price
really turns around, we could
make a profit more quickly.
Those who catch themselves with such thoughts can be relatively
sure that their inner demon is
just about to drive the trading account against the wall. Anyone
who thinks this way has lost
objectivity and is now looking for excuses to avoid the imminent
loss. This is one of the worst
habits in trading, because losses are quite normal and occur
regularly.
Profitable trading becomes impossible for traders who always let
their losses get out of hand and
then also close their winners too early. Those who realise that
although they are often right with
their analysis and their trades would have been mostly successful
but their account nevertheless
moves in the minus, face emotional problems. This inevitably leads
to a further deterioration in
trading.
Good traders are not those who do not make any loss trades, but
those who realise their losses
quickly and then move on to the next trade without accumulating
emotional burden.
8. The trade as a hypothesis
The actual trade should always be seen as a type of chart
hypothesis, which makes the objective
realisation of losses easier.
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For example, if you are analysing a Head-and-shoulders formation,
you probably have the
following hypothesis:
When the price breaks the neckline downwards, the prevailing upward
trend is not only over, but
a new downward trend is initiated since the sellers are stronger
and push the price down with
lower highs and lows and falling price waves. The sell-trade
hypothesis is active as long as the
price forms new lows. If the price breaks the last high and closes
above it, this trade idea is no
longer valid.
The trader would thus remain in his/her selling trade until the
price breaks the last high and rises
again. This approach helps in objectively determining when the
trade should no longer be held
and in avoiding panicking in the event of short-term price
fluctuations.
9. Sample-size-thinking
At this point, it is particularly important to be aware of the
actual role of individual trades. If you
are looking to become a professional trader and want to carry out
this activity for the next 15 or
20 years, you will make thousands of trades. A single trade is
therefore meaningless. You should
never let it get to the point where a single losing trade gets out
of hand, because this is not only
harmful for the trading account, but also for your mental assets.
Many traders manage to remain
disciplined for three, four or five weeks and make good trades. But
then comes this one trade
where they were so sure it would end in a profit. But they somehow
lose the overview, make
some fatal mistakes and suddenly have to realize an excessively
large loss which neutralises all
profits of the last few weeks. This is frustrating and a strain on
the nerves. If this happens
repeatedly, their mental assets are attacked and they lose their
mental capital. Sooner or later,
traders will not be able to recover and fall into impulsive
behaviour patterns. No matter how
good they trade during a short period, they always come back to
square one.
At this point, it is important never to lose perspective. You must
learn to realize losing trades
quickly and without emotions. The next trade is already waiting and
if you manage to close losses
properly, the next winning trade will have a much bigger effect on
the trading account.
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10. Five tips to deal with losses and challenges
Those, who implement the following practical tips, will soon be
able to cope better with losses
and emotions:
Reduce trade size
Most traders make the mistake of increasing their positions after
losing trades because they hope
to move their account back into positive range faster. Naturally,
such an approach rarely ends as
planned and traders often dig their own grave. The mixture of
losses, emotional agitation and
increased risk is counter-productive. Those, who become
increasingly anxious and confused,
should not exert additional pressure by entering larger
trades.
Patience is very important in trading! Each cycle of losses will
end sooner or later; however, you
should not try to speed it up by hook or by crook. Instead, it
makes sense to reduce the position
size and rebuild self-confidence. This way, you can slowly work
your way forward again.
Become more selective
Some traders tend to make indiscriminate trades in the hope of
regaining positive results faster.
This should be avoided at all costs. The worse your trades are, the
more losses you will suffer and
the variance of account movements will increase. This means that
the account development
fluctuates greatly, which in turn will affect emotions
adversely.
If you are feeling under the weather, you should make only the best
trades in order to improve
the quality of your trading and thus bring more consistency to your
results. The more stable the
account movements are, the better a trader will feel and the
pressure during a loss cycle will
decrease.
Less is more – this is especially true for the number of
trades.
Test your expectations
Misplaced and excessively high expectations soon have a
demotivating effect: they do not inspire
us, but, if they are not met, quickly lead to negative
consequences.
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Those, who believe that they can make a lot of money in a short
time, but suddenly find
themselves in a cycle of losses often tend to become impulsive and
throw all good intentions
overboard.
It is therefore important to know your behavioural pattern and ask
yourself whether and why
you want to become a trader in the first place. Independence and
freedom appear to be good
goals, but if expectations are too high and unrealistic, they will
rather prevent a trader from
achieving his/her true potential. Those, who are then confronted
with loss trades, panic quickly
and their goals are still a long way off. They quickly lose the
desire to trade when they realise that
there is no chance of reaching the ambitious goals ever.
Especially during the first year(s), it is important to realise
that trading is not a way to get rich
immediately, because you then quickly get on the wrong track. But
that does not have to be the
case! If you focus completely on yourself, learn as much as
possible and constantly work on
yourself without being tensed up and looking at the growth of your
account, you can achieve a
lot.
Objective loss analysis
Not all profits are good and not all losses are bad. This is one of
the most important findings in
trading. Anyone who breaks his/her rules, enters a trade without
following his/her rules and also
uses an excessively large position size, should not be too proud if
he/she gets off lightly again and
realises a profit by chance. Such behaviour will take its revenge
sooner or later. Furthermore,
traders tend to adopt such negative behaviour patterns in the long
run, and as long as they are
not brutally punished, they see no reason to change their
behaviour. Once you are accustomed
to undisciplined trading, it will be difficult to change this
habit.
We therefore have to get used to process-oriented thinking, i.e. we
should not judge the final
result, but our planning and our behaviour. If you plan your
trades, wait patiently until all your
criteria are fulfilled, follow all your rules and avoid impulsive
mistakes, you can be very satisfied
– no matter how the trade ultimately goes. Every trader has control
over these things. However,
how the price reacts and how the market behaves is beyond their
control. It is therefore fatal to
judge yourself only based on results alone. Objective loss analysis
always focuses only on the
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factors that a trader can control 100%; these factors do not
include price movements or the
result.
Traders should always focus on the factors they can influence
actively. This gives them a feeling of control, power and self-
assurance. You should not see yourself as a victim, which often
happens when you use your energy to change the uncontrollable
aspects.
When analysing your trades, you should ask yourself the following
question and answer as
objectively as possible: Have I done everything right? Has the
trade worked out or not? Or have
I made mistakes, am I the reason for the loss?
In addition to these questions, the trading journal of
www.edgewonk.com and its analysis tools
are helpful in objectively assessing your trading results in a
better manner.
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Not every profitable trade is good and not every loss means you
have done something wrong. It is important to judge your
performance based on decision-making and not just based on
short-term results.
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Dealing with revenge trading
Every trader knows these situations, where a normal loss trade
leads to one more followed by
another – and one wonders how it could have come all this way,
because, under normal
circumstances, one would never have made such follow-up
trades.
Revenge trading is a big problem and, at that moment, it usually
does not seem like we are
making a big mistake, but we quickly lose track and control when we
try to make up for our losses
in a hurry.
There is only one way out for those who have problems with revenge
trading: to move away from
the charts. If you notice that your inner demon is about to gain
the upper hand, you should
immediately switch off your computer and go away from your charts
as quickly as possible. Now,
nothing is more important than getting an objective perspective
again. After one, two or three
hours, the world usually looks completely different and the desire
to pursue revenge trading is
often completely vanished. In exceptionally bad cases, you can also
take the rest of the day or
the whole week off and take a short break from trading.
This is not an escape mechanism! Even if it perhaps appears so at
first glance. If you give adequate
time to yourself, you will realise that it is not so bad not to
trade for a while after a loss. It is
empowering to see that the world won't end if you do not “bring in”
everything immediately
after a losing trade. Such a change of perspective can be extremely
liberating and change the
entire trading approach.
11. Avoiding performance targets
Traders like to make calculations in which they invent weekly or
monthly returns, based on which
they hope to grow their trading account quickly into the six or
seven-digit range. However, these
calculations are usually based on the arbitrary key figures and
have nothing to do with their
trading behaviour or actual historical results. Arbitrary
calculations thus become goals that
traders try to achieve by hook or crook.
This inevitably leads to many problems, because nobody can control
the number of trades, let
alone the number of winning trades that can be realised per week or
per month. If a trader is
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below the self-imposed target and runs out of time, he/she often
tends to slide into over-trading
and force trades or increase the risk – all this only because
he/she wants to achieve the arbitrarily
set target. This worsens the quality of trading – the opposite of
what was hoped happens and
bad trades push the self-imposed targets further and further
away.
On the other hand, a trader, who quickly achieves his/her goal due
to favourable market
conditions and then reduces his/her trading activity, can leave a
lot of money on the table.
Instead of setting the performance targets, a trader should strive
for process-defined goals. As
trading coach Dr. Alexander Elder said in his well-known book “Come
into my trading room”, the
only goal of a trader should be to make the best possible trades.
Making money is then a by-
product of good trades.
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System metrics
12. Performance metrics
To develop and design their own trading system, traders have a wide
variety of options at their
disposal. However, two key figures have proven to be the most
important.
Although most traders already use these key figures in one way or
another, hardly anyone knows
how to interpret them correctly. As a result, traders often develop
their trading systems in the
wrong direction and draw the wrong conclusions. A trader, who
understands how to interpret
these two key figures in the right context and integrate them into
the development of his /her
trading system, can stand out from the mass of failed traders.
Profitable trading would then be
within reach.
The two key figures are the win rate and the reward/risk ratio
(RRR).
We will first explore the key figures individually and then see how
they determine our entire
trading and how we can use them to our advantage.
Win rate (WR)
At first glance, the WR is a very simple key ratio. It tells us the
probability of our trades ending up
winning or losing. It is based on our historical trading behaviour
and is not a constant number,
but always changes. Furthermore, the WR depends on a variety of
factors, and hence a trader
usually receives not only a single WR, but different WRs for
different areas, set-ups and
timeframes in his/her trading.
The WR is almost completely ineffective and has virtually no
informative value if we consider it
as a standalone factor. The biggest misunderstanding concerning the
WR is the assumption that
a trading system with a high WR is better and has a higher profit
potential. This is not at all true.
A trading system with a WR of 90% or 95% can also be a losing one.
For example, this is the case
when the trader always closes his/her profit trades too early and,
on the other hand, the few
losses completely get out of hand and erase all previous profits at
once.
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The WR says nothing about the magnitude of profits and losses. This
is a major weakness of the
WR when it is viewed out of context. Therefore, traders should not
make the mistake of getting
too attached to the WR.
Myth: 50% WR and game of chance
It is extremely important to understand that you can also trade
profitably with a WR of 50% or
less. Many traders mistakenly believe that a trading system with a
WR of 50% or less can no
longer be profitable and that such a system is no better than a
coin toss.
But this is incorrect and only shows that the trader has not dealt
intensively enough with
probability theory and risk management. As long as the winners are
larger than the losers, a
system with a WR of 50% or less can also be profitable. Many
professional traders trade with the
WR in the 50% range or below.
Reward/Risk Ratio (RRR)
The RRR is a key ratio that allows us to assess the possible profit
opportunities of a trade more
precisely. For a buy trade with an entry price of $100, a stop loss
at $95 and a possible take-profit
target at $130, the potential loss per position is $5 ($100 minus
$95). The potential profit is $30
($130 minus $100) and the RRR is 30: 5 or 6: 1.
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The RRR measures the ratio between the entry ($100) in the trade
and the potential target ($130), as well as the stop loss
($95).
The potential profit is $30 and the potential risk is $5 in this
case, giving us a RRR of 6:1.
The planned RRR helps traders in determining the potential expected
value before entering the
trades. If a trade offers too small a profit opportunity, the
trader should consider whether the
trade is worthwhile.
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This is comparable to professional poker or betting in sports. Even
the best hand is not necessarily
playable if the bet is too high when compared to the possible win.
The best sports betting experts
do not bet on every game and even if the outcome of a game seems
very clear, it is still not a
good bet if the possible win does not justify the bet.
If we apply this context to trading, it means: The best set-up must
be avoided now and then if
the profit potential is not good enough. What exactly “not good”
means in this context will
become clear later.
The realised RRR, often also called R multiple, is a key
performance indicator that indicates the
magnitude of the realised profit or loss as compared to the risk
taken. An R multiple of +2 means
that the profit trade has achieved a profit equal to double the
initial risk. If the stop-loss distance
was $5, an R-multiple of +2 means a profit of $10 per position. A
loss, at which the price has
reached the stop loss, is then equal to an R multiple of -1 and a
loss of $-5.
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13. The Holy Grail in trading
The WR and the RRR do not offer any benefit when considered in
isolation. Problems and ruined
trading can even occur when traders use the key figures in
isolation and draw the wrong
conclusions from them. However, if a trader knows how to combine
the key figures correctly,
he/she can reorganise and align his/her entire trading
professionally.
RRR meets WR
We first need to understand how the RRR and the WR are directly
linked. We can calculate the
required minimum WR from the average RRR. If the average RRR of a
trader is 1: 1, this means
that his/her profit and loss trades have the same size and that
this trader needs a WR of over
50% to be profitable. An RRR of 2: 1 means that two out of three
trades are winners. This trader
only needs to successfully complete one of three trades to be
profitable. This means that a WR
of over 33% is required. For most traders, it is a revelation and a
great relief to understand that
they do not have to achieve either a high WR or a particularly high
RRR. They only need to know
the correct combination.
Minimum WR
The following table compares the RRR and the required WR:
Historical WR Minimum WR
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50 % 1 : 1
60 % 0.7 : 1
75 % 0.3 : 1
The WR and the RRR are directly correlated. The curve shows the
combination of the WR and the RRR that are required by a
trader
to avoid losses.
As already explained, most problems arise when traders try to avoid
all losing trades and always
chase after enormous winners. However, it should have become clear
that even a lower WR can
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lead to profitable trading. A combination of a low WR and a
moderate RRR is sufficient for this
purpose. This brings profitable trading within reach for many
traders.
Timeframes
As we have already seen, the investment horizon and the choice of
timeframes used to identify
trading opportunities are extremely important.
Trading usually distinguishes between low and high timeframes,
which are divided into two
classes. The low timeframes are the 1-hour, 30-minute, 15-minute
and 5-minute charts. The high
timeframes include the 4-hour, daily and weekly charts.
Most traders choose one of the two categories and then restrict
themselves to the respective
timeframes. This has the advantage that the trader can make
consistent decisions and his/her
approach is clearly defined. They should always avoid jumping from
one timeframe to the other.
This is because the differences are serious.
Especially the demands on the emotional profile of a trader differ
fundamentally. In the low
timeframes, you have more trading opportunities and the patience
factor does not play such a
big role. But if a trader is emotionally unstable and quickly loses
his/her nerve after losing trades,
he/she runs the risk of quickly sliding into revenge trading or
over-trading. In the low timeframes,
you must keep a cool head and shake off losing trades quickly so
that you can perceive the next
opportunity and remain objective.
In case of trading higher timeframes, you may have to wait for
hours or even days for a new
trade. Traders who suffer from FOMO (the fear of missing out) or
are generally bored quickly
often have a hard time in the high timeframes. However, it is a
huge advantage that you do not
have to sit in front of the charts all the time and you can control
your emotions better if you have
more time to plan and execute trades. Furthermore, your holding
time will also be much higher
which has various implications and can pose challenges as we will
see shortly.
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The selection of the timeframes influences the entire trading and
different timeframes also have different requirements for
traders. It is therefore very important to be aware of the choice
of the timeframe and to adapt it as per your own strengths.
Thank you for your time and happy trading! Rolf & Moritz
Tradeciety.com
Trade entries
4. Objective exit rules
6. The 10-second rule
9. Sample-size-thinking
Reduce trade size
Become more selective
Test your expectations
Objective loss analysis
Reward/Risk Ratio (RRR)
RRR meets WR
Timeframes