Where to begin if you want to trade?

The central dogma of a trade: A trading template from start to finish.

In this series ”The Central Dogma of a Trade”, we will learn about what constitutes a trade. We will break down each component and take them one by one.

A trade has 5 essential parts:

1. Determine the Market health.

2. Determine Leading sectors and leading stocks

3. Least risk entry

4. Trade management

5. Exit

In this article, we will start with the 1st: Determine the Market health:

At any point in time, the markets will be in one of the following 3 states.

1. Uptrend: Characterised by a higher high and higher low

2. Downtrend: Characterised by a lower high and lower low, or

3. Base: Moving sideways between 2 points.

If you are a Long-only trader/investor, the best time to put your money in the market is during an Uptrend. Strictly avoid the markets during the downtrend. During the basing phase as there will be limited good opportunities, hence sitting on the fence would be a good idea.

Now, how do you decide which state the market is in?

The simplest way is open the broader market index (CNX 500 in the case of Indian markets) in the weekly timeframe (my choice of timeframe, although daily and Monthly will also work if that suits you) and mark the swing highs and the swing lows.

If the consecutive swing Highs and swing lows are higher than previous highs and lows, we have got an up-trending market. If the consecutive swing Highs and swing lows are lower than previous highs and lows, we have got a down-trending market. And, If the consecutive swing Highs and swing lows are within a previous high and low, we have got a sideways basing market.

Let’s look at an example in CNX500. The markets have just started an uptrend with a new Higher High (HH) and a Higher low (HL) in place after a 12-month downtrend characterized by LH-LLs.

In a higher timeframe, it can still be seen as a base between the high of 16,000 and low of 12,800.

Once this high is taken out by the price, the uptrend will be even stronger.

To summarize,

Markets are either up-trending, down-trending, or basing at any point in time at any timeframe. Our odds of a successful trade dramatically increase if we align ourselves in the direction of the market by going long only when the market is up-trending or going short only when the market is down-trending. And sitting out, if in doubt.

Identifying the market trend is only the 1st step. We will be discussing the next 4 steps of trade in our upcoming articles.

See you in the next one.