A Lesson on Finding Low Risk Trades
|Of all the facets of trading, the first that a new trader must learn to master before he can engage the markets with any degree of confidence is the identification of low risk entries on a price chart. Notice that not just any entry will do, only those offering the biggest reward for the least amount of loss potential will do. In addition, the probabilities have to stack up in a trader’s favor.
If you’ve ever read about or had the chance to meet a successful trader, you will find one common thread: They all (without exception) have an EDGE based on low risk entries and possess extreme discipline to execute their process.
What Defines a Low Risk Trade Entry?
I define a low risk trade entry as a price level where a trader can expose the least amount of capital to prove whether his edge will work. I tell students to look for these areas by identifying pockets of unfilled orders. These are generally found at prior inflection points or levels of equilibrium on a price chart. That is, points where is the market likely to change direction.
Specifically, inflection points can be spotted by looking for those price levels where there was a clear change of direction. In other words, where was the dominance of either the buyers or sellers relinquished? Moreover, the more powerful the reversal, the more important that point becomes on the retest. The chart below depicts a couple of these turning points in ES (S&P 500 E-mini futures).
Also noteworthy is the fact that the first time these levels were tested, not only did they provide a low risk trade setup, but they also held and reversed a high percentage of the time.
Also, when a move is underway, those aforementioned pockets of unfilled orders show up on a chart as a level of equilibrium, as we can see from the caption below.
As we can see in the chart, the level stopped the incipient rally and turned price lower. This caused the short trade to work nicely.
In the final two illustrations, I’m showing the before and after screenshot of a trade I set up for the students in the last Instructor Spotlight session I did early Tuesday, November 13. The rationale behind this trade was that the ES had been dropping (as seen by the big red candles shown in the prior chart) and inside the selling candles was a fresh supply zone. The trade was to wait for price to rally up to the Supply zone and expect it turn back down to an opposing demand zone (fresh buy orders).
Suffice it to say, not all trades will work as well as these did, but the key here is when they don’t pan out, the losses will be small compared to the profit potential.
Once a trader learns the skill of identifying these levels, the biggest challenge is putting on the trades. Why do I say this? Well, all of these trades are being placed when price is either retracing or the market is moving strongly into one of these areas.
If you look closely at all the charts, you were shorting into a series of green candles (some of them very tall); psychologically, this doesn’t sit well with most non-professional traders. Only by knowing probabilities and accepting risk can a trader place these trades with self-assurance.
The other issue is patience. These setups don’t come every minute, or five minutes for that matter – more like two or three times a day (maybe). Indeed, this style of trading perhaps is not for everyone, but regardless of your method, identifying and executing low risk entries are the hallmark of a consistently profitable trader.
Until next time, I hope everyone has a great trading week.
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