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What is a good trade?

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Mark,

What do you consider to be a good trade? It seems a lot of this post
is about making good trades regardless of money gained/lost. But how
does one define a good trade? Adhering precisely to your plan? Honoring
risk management accurately? It seems quite possible to present
exceptions that would make a "good" trade seem like a bad trade.

How do you characterize a trade as good?

Thanks,
Burt

***

Burt,

Ultimately, trading is all about making money.  To do that, you must make trades that are statistically valid.  That means taking risk, reward, and probabilities into consideration, the trade is worth making.

First, when talking about a trade, we are talking about the action of entering an order and getting filled.  That is making a trade.  It's a good trade if it meets certain conditions and is a poor trade if it fails to meet those conditions.

If you decide to make an adjustment, that adjustment trade can be ranked as 'good' or 'bad.'

However, the whole process of making the trade, i.e.,opening, holding and then exiting can also be considered to be 'a trade.'  That is not what I am discussing here. That is one reason why profit and loss are not considered.  Thus, if we want to discuss whether it's a good trade by the second standard, much more must be discussed.  For example, you asked about sticking with the plan and exercising good risk management.  Those are very important to long-term trading success, but have nothing to do with making a trade by the first definition. Yet each is very important to 'making a good trade' by the second, more inclusive, definition.



1) A good trade is one that you want in your portfolio.  It is not a random trade idea recommended by someone else, nor is a borderline trade that you wanted to try – just for the fun of it.

2) A good trade is always sized properly.  That means a worst case scenario doesn't result in a loss that is greater than you are willing or able to handle

3) A good trade has enough of a reward that it is worth seeking.  In other words, it cannot be too small to be worth the effort.  Selling OTM options for 5 cents, paying a commission, tying up margin, and waiting one month to collect what remains of that nickel is not a sufficient reward

4) That reward must be worth seeking when considering a) the probability of earning the reward and b) probability and size of the potential loss. 

If you make a trade with a 70% chance of earning $100, a 20% chance of losing $900 and a 10% chance of losing $300, this is not a good trade. Why?  On average, every time you make this trade, your expected loss is $140.

If you have a 70% chance to earn $300, a 20% chance to lose $700 and a 10% chance to lose $200, it is a good trade because your average expectation is to earn $50. 

To me, a 'good trade' is one that fits within your comfort zone, has a profit worth earning, has an acceptable level of risk, and the numbers (statistics and probability) justify the trade.

A good position (and that means the trade at a later point in time) must meet all the criteria of a good trade.  There is no point holding a position that you hate or one that you would never considering opening as a new trade. [I concede that there can be a middle ground where you neither love it nor hate it and don't know whether to hold or exit.]  A good position must be managed well, and as you mentioned, adhere to the trade plan.

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