1. Do I understand this idea?
Every investment or trading decision rests on an idea. On one extreme, perhaps the signal to buy or sell something is generated by an algorithm (a set of rules); even in this case, the algorithm is built on an idea that something should happen in the market after a set of conditions are fulfilled. On the other hand, maybe you are trading off a hunch or a gut feel.Ideas can come from many places: are you following someone on social media? Is your idea based on fundamental, macro, or technical ideas? I think the key questions to ask are do you really, fully, understand the idea and were it comes from? (For instance, many people trade-off of dimly understood beliefs about fundamentals. If you are taking a 2 day trade based on “fundamentals”, you probably have a logical disconnect.) Also, is your idea reproducible?
Is this an idea you can execute, in some form, over and over? Good investment and trading programs are built around consistency, and, for this to happen, the idea must be something you can repeat.
2. Do I understand how the market should move if I am right?
This is important, and not as simple as it seems. You think something is going up so you buy, but when should the market move? How long is it ok if the market is flat? What if it goes down a little bit, or a lot? What would be strongest confirmation of your idea? What might mean the idea has become consensus and is now vulnerable to reversal–when is good, too good?Another variation of this question is asking if your position will properly capture the market move. In some cases, this is simple: you think the Nasdaq futures should go up beyond the high of the day in the 30 minutes, so you buy Nasdaq futures–simple. But what if you think volatility is going to increase in stocks and you’re trading the VIX futures, or a leveraged ETP, or options on one of the above? Do you truly understand how those products will respond to market movements? What if you think Delta Airlines should do better than its competitors? Is buying DAL the right play there?
3. Do I understand my risk?
No, not do you know where your stop is; I mean do you really, truly understand your risk? What is the worst that can happen, and what is the probability of that worst case outcome? (As I wrote in my book, we have terrible intuition about very rare and very serious risks–this is one reason that risk management is so difficult.) Once we’ve accepted that worst-case risk, we should then begin to think about less serious risks. Do not just assume that your risk is your stop; think deeper.4. What might I be missing?
This is hard one, because the question you’re asking is what do you not know, and what do you not know that you don’t know! Many people find it challenging to think along these lines, but this is one way that we grow as traders and investors. Always ask what you don’t know. Always be learning.5. What mistakes might I be making?
More and more, the investment literature focuses on cognitive mistakes. There are important lessons here, but, to me, one of the most important is that things are “wrong” with the way we perceive patterns, risk, and probability. These errors are fundamental part of human perception and cognition, and you aren’t going to change them–you cannot fix most cognitive biases, so how do you work with them? How do you minimize their ability to harm you? Asking these questions can help you protect yourself from some serious and dangerous errors.These questions will not solve every problem you have, but they can point you in the right direction and help you work toward solutions to some of your most serious challenges.
Editors’ Picks
AUD/USD: Extra gains in the pipeline above 0.6520
AUD/USD partially reversed Tuesday’s strong pullback and regained the 0.6500 barrier and beyond in response to the sharp post-FOMC pullback in the Greenback on Wednesday.
EUR/USD meets support around 1.0650
EUR/USD managed to surpass the key 1.0700 barrier in response to the intense retracement in the US Dollar in the wake of the Fed’s interest rate decision and Chair Powell’s press conference.
Gold surpasses $2,300 as Dollar tumbles
The precious metal maintains its constructive stance and trespasses the $2,300 region on Wednesday after the Federal Reserve left its FFTR intact, matching market expectations.
Bitcoin price reclaims $59K as Fed leaves rates unchanged
The market was at the edge of its seat on Wednesday to see whether the US Federal Reserve (Fed) would cut interest rates during the Federal Open Market Committee (FOMC) meeting.
The market welcomes the Fed's statement
The market has welcomed the Fed statement, and the S&P 500 is higher in its aftermath, the dollar is lower and Treasury yields are falling. There is still only one cut priced in by the Fed.
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