For those who are just starting out in trading the question comes up quite often, “why analyze the market?”. Actually, the answer is quite simple. We analyze the market to determine entry and exit points which are most likely to yield a profit over time.

Our overall objective in analyzing the markets to determine entry and exit points is to maximize profit will while at the same time minimizing risk. You see, we must control our risk as it is of paramount importance if we are to trade successfully.

You see, those who trade the markets successfully do not do so by selecting entry and exit points at random. They determine good entry and exit points through market analysis. Rather than trying to find entry points which are, “perfect” or “absolute best” or “optimal” successful traders look to find entry and exit points that are profitable. This is not to say that they are not looking for what may be termed the best possible entry and exit points under the circumstances. With that said, finding profitable entry and exit points will yield more success than looking for the ultimate optimal entry and exit points. In the world of trading continually searching for the ultimate and optimal entry and exit points may be termed, “paralysis by analysis”. The previous statement is not meant to minimize the importance of research, but to emphasize the importance of the application of the research in real world trading.

So what important information can we gather from analyzing the markets?

One – analyzing the markets can help us find which particular financial instrument to trade. For instance, if you are stock daytrader then you would be looking for stocks that have sufficient intraday movement to provide you ample opportunities to capitalize on.

Two – market analysis helps us to determine the level of working capital that we need. Some markets and trading systems require more working capital than others. Determining the right level of working capital for the markets chosen is extremely important. In fact, having sufficient working capital is of great importance in any business. For instance, if you are going to trade a portfolio of 100 stocks then quite logically you will need more working capital than you would if you are only trading a single stock (trading the same number of shares).

Three – market analysis helps us to control our risk. You’ll find I stress risk control a great deal and that is because as previously stated risk control is of paramount importance. The reason risk control is of paramount importance is that lack of risk control can quickly take you out of the game. For instance, if you risk all of your working capital on one single trade and that trade moves hard against you, that’s it. If you ignored risk control to the point that it has emptied your trading account then it seems logical that you simply will not be able to take advantage of the many future opportunities that would’ve been available to you. It is therefore critical to understand and know your level of risk prior to entering any trade.

Four – analyzing markets helps us to select entry as well as exit points. There are numerous entry and exit points during any market move which can yield a profit. There are those who believe that you can enter at the exact beginning of a strong up trend and exit at the exact moment prior to it turning into a downtrend. I would have to openly say “hats off” to anyone who can accomplish such an incredible feat. Fortunately it isn’t necessary to pick the exact top or bottom of any move in order to trade successfully. There’s plenty of money to be made grabbing the, “lions share” that lies in between the top and bottom of the move.

Five – market analysis helps us to accept and know when to do nothing. This is one of the most challenging concepts for beginning traders to grasp. Often times, new traders feel they have to “always be doing something” or else they will not be profitable in the long run. Nothing could be further from the truth. Knowing when to stand on the sidelines and not trade is not to be taken lightly. Good market analysis will show that not all market conditions are conducive to your trading method’s profitability. For instance, your trading method may filter out periods of extreme volatility. If your analysis has determined that your trading method does not function well in periods of high volatility then it makes perfect sense that you should be on the sidelines. The same logic applies for periods of extremely low volatility. Your analysis may have determined that during these periods that there are fewer opportunities for profit especially when weighed against the potential risks involved.

So as you can see there are many benefits to analyzing the market. From entry and exit points, to risk control, to what to trade, market analysis is essential to the success and continued success of any trader.