I go through a mental checklist in my head before determining when to enter a trade. There are probably a million variables that a trader can look at. However, you don’t want to corner yourself into analysis paralysis. Additionally, everyone analyzes different variables depending on their strategies. These are the ones that I tend to look at and I find are pretty common amongst many investors.
When To Enter A Trade
My checklist includes six major factors. There are probably a lot of other smaller factors that could be included to optimize the trading strategies and help determine when to enter a trade. But at the very least, I look at these six items: market trend, price and volume, technical indicators, earnings report, company specific events, and macro events.
Trader’s Checklist #1: Overall Market Trend
Before deciding when to enter a trade, I take a look at the overall trend in the market. Is the trend up or down? If the markets are up, how much are they up and how long has it been that way? The same thing if the markets are down. Afterwards, I check to see how stock XYZ is reacting to the market trend. I tend to enter a trade if XYZ is trending along with the overall market. Additionally, if XYZ is pushing strong greens while the market is down, that could mean XYZ is a very strong company with great prospects.
Trader’s Checklist #2: Price and Volume
If XYZ is up, is it up on high volume? If XYZ is up but there is little volume behind the price movement, that is not very indicative of strength. Seeing this could be a bull trap. Organic price movement is driven by market volume. Lower volume could mean consolidation and slow profit taking. Like a poker player with a good hand who slowly antes up the pool and stringing people along. Then at the peak, he pulls the rug under them and takes everything. The same can be said for stock XYZ being up on low volume. So be careful with this before deciding when to enter a trade. You can see volume data for a stock on Yahoo! Finance.
Trader’s Checklist #3: Technical Indicators
I like to pull up a chart on TradingView to quickly skim through the technicals. I don’t place too much emphasis on this but if the chart looks like falling knife, that would deter me from entering the trade soon. From the technical charts, we can see if the XYZ is overbought or oversold. The Relative Strength Index is the technical indicator you can use to determine whether a stock is overbought or oversold. Additionally, I also check the MACD. Is the MACD indicator trending higher or lower? When you hear the news about golden crosses or death crosses, they’re referring to the MACD.
Lastly, is XYZ trading outside of its Bollinger Band limits? The Bollinger Band is a guideline that shows where the 2-standard deviation range is for a stock’s price movement. If you remember your statistics, 2-standard deviations is a 95% confidence interval. Therefore, you can safely assume that a stock’s price movement will highly likely occur within the Bollinger Band boundaries. If it’s trading outside of the Bollinger Band, it won’t be for very long. Then that may be when to enter a trade.
Trader’s Checklist #4: Are earnings coming up?
An earnings event can drastically sway the stock in one direction or another. Depending on your outlook of the company and your risk tolerance, you may want to steer clear if an earnings event is coming up. In July 2015, Google’s stock jumped 22% in one day after an earnings report. If you’re a longer term investor, then earnings won’t mean much to you in the long run. As long as the company is doing well. Additionally, volatility increases as you get closer to earnings, thus driving the premiums on options higher. If you’re a volatility seller, this might be when to enter a trade on the short side of options volatility premium.
Trader’s Checklist #5: Company Specific News
Apple is notorious for having company events like “Let’s talk iPhone” or Apple’s Worldwide Developer’s Conference. These events have a potential to move the stock, both leading up to the event and on the day of the event. We throw around the saying “buy the rumor, sell the news”. This seems to have been the pattern with Apple’s iPhone announcements. Additionally, keep a looking out on pending lawsuits and investigations. An SEC announcing that they’re investigating Bill Ackman’s short sale of Herbalife will pump up Herbalife stock on good news. These are hard to predict but can affect when to enter a trade.
Trade Checklist #6: Macro-economic events
Is there an impending Government shutdown? Are the FEDs planning on tapering? Are we at war? These factors drive the overall market which could trickle down to stock XYZ. To assist with this, MarketWatch has an economic calendar which I use to identify economic announcements. These include jobs reports, Consumer price index, and Government budgets. Also, with the Fed steadily raising interest rates, the FOMC calendar is good to take a quick glimpse at to see when they’ll meet. From there, you can look at the CME Fedwatch Tool to gauge market sentiment and probability of raising interest rates.