Professional traders look for “high-probability” trades. The following are 5 questions you should know before making a trade.
Let's say that the EUR / USD is in an uptrend and you see an opportunity to buy the currency pair. You would most likely just execute the trade if you were trading purely on the data of a single chart or setup. That is a recipe for disaster. At minimum, it is important to take a look at the general trend in the market because due to the absence of the markets sentiment can lead to unnecessary losses.
Fundamental indicators, technical indicators, and the market sentiment are three factors that can and will affect every trade. If you wait for those factors to align in your favor, you have a far greater chance of reducing your risk and landing a potential profit.
Ask yourself these 5 questions to help determine whether a trade is worth the risk or not:
1. How deep is the retracement?
In trading, a very strong retracement is much more difficult to recover than a failure decline. Buying after a deep correction in an overall uptrend is generally a lower probability trade than buying after only a small retracement. The general rule is that a deep correction increases the risk of the currency pair breaking its uprend.
2. What is the fundamental reason behind the decline in the currency pair?
If the decline in the currency pair was triggered by a very disappointing economic data such as an abysmal report on consumer spending, then this is a trade you should probably not take because the short-term fundamentals are not in your favor. If there is no major reason or news to explain the dip, there's a greater chance that the uptrend will resume and you may make profits on this trade.
3. What is in the economic calendar for tomorrow's news releases?
You should also place importance in checking if there's a piece of economic data scheduled for release over the next 24 hours that could affect the currency pair you want to trade.
When the trading the EUR / USD pair, if England's retail sales are on the market and the calendar believes the data could be strong, it creates a higher probability trade. This would also be true if there is US economic data on the calendar that the market expects to be weak. However, if there is reason the British data is expected to surprise by being on the downside or the US data is expected to surprise to the upside, then it may be better to pass on the trade.
4. What is the general sentiment in the market? Does it support the trade?
Considering the general sentiment in the market is also very important. If the Dow dipped 300 points, there is a good chance that the European markets will trade lower in the next session. It may not be such a good idea to buy the EUR / USD on a dip after a sharp sell-off in stocks because the dip could turn into further losses if traders in other countries join in on the selling.
However, if the general sentiment is steady and equities ended up, flat, or only slightly lower, then the trade looks good. There is a greater chance that the rally in the EUR / USD will resume if the general sentiment is actually positive with traders optimistic enough to rally stocks.
5. Which key levels could affect the trade?
If a dip in the EUR / USD stops just above a significant support level like 1.3000, assuming the support level continues to hold, going long EUR / USD would be a higher probability trade. If that same trade broke below the support level, then there is a greater probability for additional losses if support turns into resistance.