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Book: Kane Trading on: Trading ABCD Patterns
Kane Trading on:
The Critical Elements of a Trade

In this article I will lay out the Kane Trading philosophy on what I consider to be the critical elements of a trade. I frequently refer to the sum of these elements as the 'Plan for a Trade', and hence I use these phrases interchangeably. This article is designed to be an overview, not a fully detailed, all encompassing treatise. I only point this out so that it is clear what the purpose and scope of this article actually is.
I am going to present the critical elements, and explain in some detail a little bit about each element. After digesting the article it is my hope that you will understand the concept of a trade as I see it. At this point you can then go about making your own decisions on how you can develop these areas into a personalized plan for you, a plan that fits your own goals, risk tolerances, and individual lifestyle.
Notice that I'm emphasizing 'you' a lot. That's part of the larger scale Kane Trading philosophy. I don't believe there is a plan that can be given to you, and then off you go, an instant success. I feel that you must develop each component on an individual basis, never losing sight of the fact that it must be custom tailored to you and your needs. What I want to provide here are what I feel to be the critical elements, so that when you work on your plan for trades (note that this is different than the all-encompassing 'Trading (or Game) Plan'), you will have an idea of what you need to include in this plan.
Is it possible there are other important elements that you should have in your plan that I won't mention? Absolutely. Once you get to understand my way of thinking, this question won't even be worth asking; you'll already know the answer. I am presenting what I feel are the critical elements of a trade, for me. I could never presume to know if they are the entire group of critical elements for you.
That is a big part of what I am attempting to teach with this website, and the products that I offer on it. You must develop your own plan, your own trading style, based on you. I want to present things that I wish I had known; things that I wish I had been shown early on, because I feel that these things would have saved me time and money. You look them over and decide, on your own, to use, modify or reject the things which I present. With all that said, I will present my elements, and leave it to you, the reader, to use all or part of them, and to add others if you feel the need to.
The 4 critical elements of a trade:
    1) Potential trade area (PTA): You want a reason why you think this is an area where          you want to be involved in this issue
    2) Entry technique: You then want a trigger that tells you, once in the area where          you want to become involved in the trade, that now is the time
    3) Trade size: You must decide, by doing some simple calculations, what the trade size          will be
    4) Trade management: You want to have a plan in place, before you even consider
         getting in the trade
, that tells you how you will manage this trade, whether it goes for
         you or against you
I can't emphasize enough, though; these are not the elements of the 'so called' 'Trading (or Game) Plan'. (Please see my very brief free article entitled Kane Trading on: The Difference Between a 'Plan for a Trade' and the 'Trading Plan'.) These are the four elements that I feel are critical to initiating a specific trade.
These four elements say nothing about how much capital you would use on the trade, how much capital you would be willing to put at risk, what trading vehicle(s) you might use (futures, options and/or option combinations, single stock futures, stock, etc.), and so on. These things are part of the 'Trading Plan', or 'Game Plan', as it is sometimes called. Here we are looking at just one piece of the larger scope 'Trading Plan', the immediate and critical elements that get you into a specific trade. With all that said, let's look, now, at the four elements in a bit more detail.
In element number one, we are looking for an area that we want to trade in. This area is determined by whatever style and technique you have in your larger scope 'Trading Plan'. An example that might be a part of this element could be determination of potential support or resistance on the timeframe the trade is going to be traded on. The entire book Kane Trading on: Advanced Fibonacci Trading Concepts revolves around element number one.
In that book I purposefully tried hard to focus on using the techniques I presented just to find areas where a trade might be considered. I continually mention, probably to the dismay of some of my readers, how I will avoid much discussion on entry and management techniques. The reasoning is that I want to present material that doesn't span across the four critical elements, when possible. This way, if a trader is seeking information on just one of the elements, he or she doesn't have to pay for, and wade through, material that isn't of interest.
So the gist of element one is to find an area that you think is a 'value area' for a trade. A place where you think that the reward/risk is to your favor, and where you feel that you have an edge. To do this, you must develop specific techniques that specialize in fulfilling this need. The book mentioned above is just one of many, many possible ways to fulfill this need. Traders must determine, for themselves, how they want to meet the needs for this element.
Element number two is the specific entry technique. This logically comes after you have decided on an area where you are willing to take a trade. Now that you want in, do you just jump in? Only if you want to get squashed like a bug. This is where all those sayings come into play, sayings like 'Don't try to catch a falling piano…' and so on. The entry technique tries to keep you out of trades that aren't behaving the way you would expect that they would be behaving, in the area you have determined that you might take a trade.
One of the things that I want to point out is how the first two elements compliment each other. I see many traders using similar techniques to the entry techniques that I present in Kane Trading on: Entry Techniques, but using them as their sole criterion to enter a trade. Let me present an analogy of sorts.
I remember a study I once heard someone talking about on the effectiveness of the 'snap back reversal' as an entry technique. The study, as best as I can remember it, compared the snap back reversal as a stand-alone technique to its use in conjunction with a potential support or resistance area in an established trend. Without getting into the exact details, or into critiquing the study, here's the main point of what was found. As a stand-alone technique, the snap back reversal failed miserably, something like less than ten percent effective. On the other hand, when combined with an 'area to trade' (in the form of potential support or resistance), the effectiveness jumped way up, to something like over seventy percent effective.
Again, instead of getting involved in critiquing the methods used, let's focus on what the essence of this study shows us. It's clear that the entry technique alone was pretty useless, but when combined with a well-chosen 'area to trade', it seemed to blend and form a synergy. In my experience, that is exactly what happens. That's why I emphasize the critical elements of a trade the way I do.
I've seen traders who are pretty good at finding areas to trade, but they choose to trade without any entry techniques at all. If it 'hits the zone', they are in. I also see these same traders from time to time, squished to the pavement, under a fallen piano filled with concrete, as the issue showed no respect for the area at all. Good entry techniques can frequently provide the confirmation needed to keep one out of most of those falling piano trades.
I've also seen traders take entry techniques and just apply them whenever they appear. An example I've seen is using moving average crossovers whenever they appear, regardless of any context. Sure, you may catch a few nice long trends doing that, but the rest of the time you'll likely get chopped to whipsaw pieces and give back more than you'll ever make with the few trends that you catch. This is the opposite side of the coin, using an entry technique without it being in an 'area to trade'.
Element number three is the determination of the size of the trade. To make this calculation I need three things. I need the dollar amount that I am willing to risk, the protective stop loss point, and the entry point. Some simple arithmetic then gives me the trade size. Understand that this section is a simple calculation of the trade size, and no more.
This section does not cover calculating or deciding the amount to risk, maximum allowable trade size, or anything of that nature. Those things come from the master 'Trading Plan', and are 'imported' into this section for use in the calculations of trade size. This section is only included as a critical element of a trade because in order to initiate any trade you must say what size you want the trade to be. The scope of this element, in the context of the 'Plan for a Trade', is strictly limited to this one simple calculation.
The fourth critical element is management of the trade. Now why is management, something that happens after the trade is initiated, lumped into this plan, with the things that get us into a trade? Simple. It's critical to determine how you will manage the trade before you enter the trade. The reason for that is pretty simple. You don't want to be making critical decisions in the heat of battle.
When I enter a trade, I have already decided how I will react to every possible outcome. I mean that literally, every possible outcome. I figure out every possible variation on the outcomes and pre-decide what I will do. This way I can be an execution robot when in a trade. All decisions are made in the calm cool of the off-market hours. Then when I trade, I am simply looking for certain 'patterns' and when I find them, I make my decision as to whether or not I want to take the trade.
If I do choose to take the trade, I already know where my initial protective stop will be, how and when I may take profits (note that this does not necessarily mean 'profit targets'), how I may move up my stops on a trail, and so on. Every trade I get into, and I mean every single one, you could freeze time at that point and say "Jim, say it goes up x points to here, turns and goes down y points, then turns and… what would you do?" I will be able to answer instantaneously without thinking, every trade, every time.
I have developed this skill over many, many years of trading, and I can do it 'instantaneously', because I evolved to doing a fair amount of daytrading, where 'instantaneously' is the slowest that you can be. Any delay and you are toast. In position trading or swing trading, with timeframes that may range from 2-5 days and up, you have a little 'lag time' to double check your plan, and then execute the pre-determined management guidelines (assuming, of course, that you aren't in the midst of a 'market shock' event).
This in no way implies that the guidelines aren't fully pre-determined, it simply implies that perhaps you don't have to be able to spit them out off the top of your head in an instant. For some traders, it's fully adequate to have the management guidelines written out in detail right next to the computer, and to utilize them that way. The greater point is that they are fully planned out ahead of time, before the trade is initiated.
This is all pretty commonsensical, if you think about it. Management may be required one millisecond after the trade is initiated. We've all had trades where we swear 'The Universe', or 'The Market', or whatever, is out to get us, because the instant we initiate a trade it turns and goes like a rocket against us. (I'm fond of saying, perhaps all too often, "That's what stops are for.") I don't want to be in a situation like that and have to figure out, on the fly, how I want to manage the trade, or where my stops should be. There is no time for figuring out anything at that point; you must be able to just react. Also, in many types of trades, you may want to put the initial protective stop order in with the original entry order.
Another scenario, albeit a more pleasant one to deal with, is when a position you are in rockets in your favor, a real blow-off move. When do you take profits? Some say 'What's the difference, you're making a nice profit regardless?' I feel that you must maximize this golden opportunity. To do so, you need to have a management plan in place, such as a trailing stop on some of the position. But how much of the position, and what kind of a trailing stop? (See Kane Trading on: Trade Management and Kane Trading on: Trailing Stops for more information on this topic.) If the market explodes, especially in daytrading, you don't want to be thinking 'What do I do now?' The time to decide things like this is before you even put on the trade.
So those are the four elements that I consider critical to entering a trade, with a whole lot of my personal thoughts included along the way. The reason behind my presenting this article is to make clear how I look at various aspects that I consider critical to planning a trade. This way, readers can see the 'mindset' of the Kane Trading philosophy, and decide if it makes sense to them. Please note, though, that this article wasn't designed to provide detail in each of the areas outlined. It was designed simply to present the areas, and explain what each area encompasses.
I am pointing this out because as the article progressed, I made references to books and articles that I offer, in order to provide sources for some of the detail and content that is outlined in this article. I personally dislike websites (some of them actually paid websites) where every article is clouded in references to techniques that are part of materials the writer has for sale. The writer tells you basically nothing, but hooks you into thinking that the hidden secrets he or she sells are where it's at.
The point, then, of sites like that, is to tell you enough to make you think you need to buy their products. The articles are then embedded with dozens of links to their products, and every reference to what technique you should use is another hotlink to buy another product. Why mention all this? Because I want to make it clear that this article, and this website, are not designed in this way. I make references above to help the reader locate products on this site that are pertinent to the area that we are exploring at the time, in order to save the reader time trying to search the site to find additional material, if they feel they want to further pursue that topic.
I feel this article is a 'stand alone' article. I think the content is very valuable. I wish I had found this simple layout when I started trading. I didn't see the difference way back then between an area to trade and an entry technique, and so on. If you don't want to purchase any of the Kane Trading products mentioned, or any other products on the site, that is fine. If you have found anything valuable for you in this free article, please use it.
Nothing in this article requires any Kane Trading products or techniques to be used. You can choose your own areas to trade, your own entry techniques and your own management plan. If you already have all that, but didn't see how they fit together, then perhaps this article has clarified a few things. What I want to make clear is that this free article is designed to introduce some critical Kane Trading concepts and give you a chance to see aspects of my approach, not to try to hype and suck you into buying products.
But I also need to make it clear that the purpose of the site is to provide quality trader education and for me to make a few bucks doing it, as outlined on the About Kane Trading page. If all I did were free articles I wouldn't be able to cover my expenses, nor make any money. So I have to balance some promotion of the products that I have for sale with good, quality cross-referencing for the readers benefit. I hope that I have struck a reasonable balance and made clear where I stand, all the while presenting some valuable information for the reader.
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