Lasertrader's Place

A Potpourri Of Trade Ideas and Setups

It’s All About The Setup – The Key To Consistent Profits

Posted by lasertrader on December 4, 2011

Every day I see so many trade ideas on Twitter/Stocktwits, the financial media, free emailed stock ideas, blogs etc. The list is endless. With all these great ideas, why aren’t all traders rich and making money. All we have to do is trade those ideas. Why do many fail and lose. The answer is that most technical traders do not have a day in and day out process with a defined setup or setups that they focus on consistently. Most traders are continually looking for the next undiscovered indicator, the next holy grail or just plain following who they perceive as the new hot hand. They never take the time to define their own setup, their own business plan and run their trading as their own business.

The reason I am writing this post is because of a discussion that Pradeep Bonde of Stockbee has been having on his member site the past couple of days and is continuing. He has a free public blog and a pay service (I just noticed there is some additional material about the topic of this blog post in his public blog). The discussion is focused on setups. What is a setup, why it is important, why a setup has been at the heart of the famous successful traders like Livermore, Darvas, Zanger and O’Neil. With Pradeep’s permission I am providing one post from this multiple day interactive tutorial/discussion. Read it a couple of times. Post it on your wall. Ask yourself what is your setup that makes you money day in and day out?

A good setup idea can change your financial future forever…..

If you do not understand the concept behind setup selection you will struggle for many years.

Scanning for stocks is not going to help you. Preparing elaborate watch lists is not going to help you. Unless you understand setups as key to profitable trading you are unlikely to make much money.

IBD method might be about momentum/growth but ultimately it boils down to setup and IBD has very strictly defined setups.

Same way any successful trader has well defined setup and then they exploit it day in and day out in favorable market conditions.

If you have well defined setup , you would be able to instantly recognize good opportunities and enter or exit them.

If you have well defined setup, you will be able to prioritize ideas and not waste time on marginal stocks or others ideas.

If you have setup oriented mentality you will ask everyone who posts trade idea to find out what setup generated that trade.

If you have well defined setup you will know instantly your entry, exit stops rules and not be a clueless person post entry. You will not be asking others what you should be doing.

If you have well defined setup, you will not be easily influenced by any and every new tactic people talk about or sell as the new new thing.

If you have well defined setups you would not be making new rules and adjustment everyday.

If you have well defined setup you don’t need CNBC, Cramer, Stocktwits, Stockbee site, or any other distraction. All you need is your software to generate your setup idea and your own guidelines

Setup selection is the only way to eliminate the problem of cognitive load involved in trading.

Sooner you understand that the better it is. Key to “profitable” trading is setup selection.

In the beginning master just 1 or 2 basic setup. It will take you 3 to 6 months to perfect it. Most people who have very well defined setups have taken 5 to 10 years to arrive at it. This series of posts will help you compress that period to 3 to 6 months if you seriously put your heart or soul in to it.

and you just need one or at best two well defined setup ideas to make lot of money in the market.

A good setup idea can change your financial future forever…..

It is my contention that you only need to trade 2 or 3 solid proven setups that meet your risk tolerance and personal style to be sucessful in this business. For me they are Bull Flags, Bear Flags, Horizontal/Rectangle Consolidations within a trend. Many trade Cup n Handles, Head and Shoulders, Triangles, Diamonds and many more.

You dont need to trade them all. Stockbee continually refers to the risk of Cognitive load that most suffer from in this business. If you make it too complex or worry about too many things, your mind will become so overloaded you will find you aren’t effective and confusion or mental gridlock occurs. The key to success in this business is simplicity and repetition, doing the same thing day in and day out.

Ask yourself. What is your favorite and most profitable pattern? Can you define, entry/exit/stop for each of your patterns? Can you describe your your pattern and how to trade it in simple terms to someone else? Do you keep adding other indicators to your patterns? Do additional indicators help or do you imagine that they do?

A solid tradeable pattern can be identified just by looking at price and volume. Many including myself will argue that you can be profitable with just price and volume patterns on your charts. I will admit that I am not a purist in that respect. The fact of the matter is that Techical Analysis is being practiced by many and even has become the core of Financial Media that used to call it voodoo up until just a year or two ago. With that many eyes on Technical Analysis you may want to include a couple of indicators on your daily chart because so many eyes are on them that they can be self fulfilling. These could include the 20ma (because its the center of a Bollinger Band), the 50ma and the 200ma. Don’t get carried away. All you want is something to help you confirm the validity of your pattern. If it doesn’t do that, then take it off your setup.

If you enjoy being part of the community on Twitter/Stocktwits your goal should be the see how many setups you can post to the stream. Its amazing how focused you can get on your own setups when you place them in public for many to see. Your goal with Twitter/Stocktwits should not to be to get trade ideas. If you see someone post an idea, try to figure out what their setup is. How does it match your setup and can you learn how to make your setup more effective by seeing how others define theirs.

In my opinion one of the best ways to use Stocktwits is to take advantage of the charts posted on Chart.ly. Try this process. Identify, on your own, stock trade opportunities that match your setup. Post the chart to Chart.ly. Then..only after you posted your setup..type the symbol into the Chart.ly search box and look at all the charts of the same stock that have been posted by others. See if their setup matches your own. See if there is something you can learn from their setup on the same stock that will help you define your setup better.

ITS ALL ABOUT THE SETUP

I will close this post out with..a setup IS NOT

- something Cramer recommends

- a stock that is so oversold it “should” bounce

- a stock that is so overbought it “should” pull back

- anyone else’s idea you follow blindly that does not match a pattern you already trade every day

- any trade based off a macro theme such as “financials are toast, they will keep dropping”

- a hot tip you got from some “insider”

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3 Responses to “It’s All About The Setup – The Key To Consistent Profits”

  1. Most chart patterns are defined by price, volume and time. Symmetry is very important to the success of a trade. I would also add that describing a pattern is not the same as defining a pattern. I’m curious what pattern you trade the most, the best and the worst. And, how you calculate that those success rates. I have found that the success rate of different patterns fluctuates and is a valuable tool in defining the stage of the advance / decline.

  2. Thank you for your comment Sheldon. In retrospect I wish I had taken the time to keep metrics on every trade and pattern. I’m sure you are aware of Bulkowski (http://thepatternsite.com/) and his extensive analysis of every pattern imaginable. What do I trade the most? The answer is, it depends. The other side of this whole discussion that isn’t addressed in this post is what a trader does to, as you say, determine the current condition of the overall market itself. Are we trending, are we consolidating, where are we in the consolidation. In a trending market I prefer horizontal consolidation / channel digestions of a move up or down. In a sideways market, bull and bear flag patterns work best for me at the top and bottom of the sideways channel. In addition, the overall state of the markets can determine what the the targets and stops should be for a given move. Even without an overall market assessment tool I find that its relatively easy to tell when the patterns have been working best all of a sudden start failing. Experienced traders adjust to this. Inexperienced traders may keep trying the same setup too long. That’s why I think you need a couple of setups.

    Of course, a lot also depends on your time frame that you trade in. My style looks for patterns and stocks that can give me a 3% to 10% move in 1-3 days. Others may trade much longer time frames and are willing to look at bigger patterns looking for the famous 200%+ CANSLIM type moves.

    I follow your posts on Twitter and have much respect for your work. This post as written is geared towards the less experienced trader to get them focused on a defined methodology to build upon. As you and I get more experienced we try to maximize the number of profitable trades by using the right tool for the job at hand.

    I hope I’m not rambling too much. I wasn’t sure how to provide a concise response to your question.

  3. Response is good. I’m always trying to see new ideas, etc.

    I generally trade from 23 patterns (long & short side) combined. If I do not see these patterns I just sit and wait, otherwise I am just chasing the market…not good as we both know.

    A lot of good information in your post for all traders, not just the less experienced.

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