Warren Buffett has a famous quote about his investment strategy that boils down to… “it’s not about the asset you buy; it’s about the price you pay for it.”
I’m paraphrasing, but the general gist is that, for Buffett, buying value is the only way to go.
It has certainly worked for him. 70+ years into his investing career, he’s now worth something like $80 billion and is among the richest people in the world.
But (sorry, Warren) trading is different from investing.
Most traders, when they start out day trading or short-term trading, do exactly what Buffett suggests — they focus on the entry almost entirely. And this isn’t entirely wrong. Value matters when trading too. But there’s more to pay attention to when working in the short term.
Take Roger Scott. For decades he’s been developing and executing incredibly effective trading strategies based on his years as a hedge fund trader. He has a technique right now that’s racking up gains of 800%+ in just a few days…
You know what he doesn’t do?
Get caught up in the value argument. Because he’s a trader.
On one level, I get it. Novice traders perceive markets differently than professional traders do, believing that with the right entry method they will gain some control over the outcome of their actions.
We all want control.
Think about it on a deeper level. The only control traders have over their positions occurs at the time of entry. Once the position is entered and filled, we lose all control over the position and are at the mercy of the market to do what the market is going to do.
Before entry the we have full control over everything — the position, the account and even the market. Yes, you control what the market will do TO YOU by avoiding entering the market entirely.
So, looking from a pure psychological perspective, you give up all control when you pull the trigger and enter the position. That’s uncomfortable.
Most of the time this happens on a subconscious level and we don’t even realize this is happening, but it is.
But That’s Backwards
Most traders don’t spend nearly as much time thinking about their profit target compared to their entry strategy, but your profit target is responsible for how much money you make.
It’s as simple as that.
It’s the concept of Positive Expectancy that’s the key to a winning trading strategy.
When you want to minimize your losses and maximize your winners, both sides have more to do with your Exit Strategy than your Entry Strategy.
You minimize your losses by placing stop losses that are effective without stopping you out prematurely…
And you maximize your winners by implementing a profit target or a trailing exit strategy that allows the market to maximize its momentum without exiting prematurely.
But how do you do that consistently? By watching the ATR Indicator.
The ATR indicator measures the daily or intraday trading range based on the actual volatility of the stock, futures or forex contract that you are trading.
Even though the ATR indicator was created 4 decades ago it remains one of the best indicators for measuring current volatility. What I like the most about it is how it adjusts dynamically as volatility changes bar by bar or day to day, depending on your time frame.
This allows the market to tell us where to place stop loss orders and profit targets instead of us imposing our will on the market.
And this is important because trading is not one-size-fits-all. Different markets produce different levels of volatility at different times. By using actual market volatility to measure our stop loss levels and profit targets we give our positions the breathing room they need, while at the same time the protection level necessary to achieve the best risk-reward ratio.
And that’s how you retake control over your trades, without fixating on the entries.
Beyond divergence, Moving Average Convergence Divergence (MACD) is another one of my favorite trading indicators, but it’s not an easy one to make sense of. It’s a trend-following momentum indicator that is designed to compare two different moving averages around a single trading asset. Like I said, not easy. But once you understand how the MACD line is calculated and understand what each of the three parts of the indicator calculate, it becomes very simple to understand and put into practice. And it’s one of my favorites. Here’s how to use it yourself…