Setups! Finding, Defining & Testing Them

[timsk]

If you do a search for threads with ‘Setup’ in the title, you’ll find only eight. One of these relates to hardware setups, another five discuss setups in general terms or focus on a particular well known one. The remaining two threads do explore how traders might go about finding, defining and testing prospective setups, but both threads are on a private members forum. It strikes me that it would be in the interests of the wider T2W community to have a thread which attempts to explore this vital topic in some depth.

Anyone who follows the posts of dbphoenix will know that this is a subject about which he has strong views. “Unless one has defined the setup, he cannot have tested the setup. If he has not tested the setup, he has no idea of the probability of its success. With no idea of the probability of success, any trades made off the undefined setup are essentially guesses”. A logical argument, forcefully made. But before you define a setup, you have to find a new one - or choose an existing one, which in itself isn’t always easy.

The purpose of this thread then is to focus on the process of finding, defining and testing a setup. How do you do this? Just as the thread ‘A Trading Plan - You MUST Have One!’ was started with the hope of creating a template; similarly, it is hoped that input from members on this thread may result in a step-by-step guide which any trader can follow to help them complete what is arguably the most complex part of any trading plan.

Tim.

 

[timsk]

What is a Setup?

For those interested in this, an obvious starting point would be to arrive at some sort of consensus as to what a setup is and, just as importantly, what it is not. Here's a simple definition for starters:

'A setup is a specific set of market characteristics that are well defined, tested and easy to spot in real time in order that a trader can identify a prospective high probability trade prior to his/her entry trigger'.

 

[fxmarkets]

so we could bracket all that doesn't meet the above as "Simply Idea's" which may well lead to discovering a valid setup.?

 

[OpenMind]

How well defined should setups be? Is the statement "I plan to trade breakouts of triangles on daily charts, provided the the volume in the triangle was much lower than the average volume" an entry setup for example? Or are we talking about defining a) what is a triangle, b) what is lower volume c) what is a breakout and so on in a language that a machine can understand?

The danger in the second approach is that it can lead to analysis-paralysis. We could easily define our setups for all our life without ever trading them (because the machine-readable definition is never perfect, so we keep making it perfect), and it could go all very semantic.

I personally define my setups loosely (like the statement above in quotes) and since I am an end of day trader, I take my time to decide if I should take a trade. Whether the stock 'feels right' is a large part of my entry decision.

Just my two pence. Most of you will probably disagree.

 

[Tuffty]

Excellent idea Tim. My initial thoughts are:

I have a conceptual problem with seperating a setup from a trade. Either you trade or you don't. You have to test the trade rather than the set up. You can tweek the set up, but the results you get will be dependent on the trade as a whole. A good setup with bad stop management will not be a good setup.

 

[Grey1]

Before using any kinda set ups you MUST and I insist you MUST identify the TIME FRAME you are using to look for that SETUP...( 1 min , 3 min 12 min 17 min 43 min , and so on )

For every min there is a chart for every chart there is a trade able set up but which set up is the dominant one ?

The question is how to identify the correct time frame for a particular instrument ?


Since this thread is not about identifying the time frame then i wont expand on that

grey1

 

[timsk]

Since this thread is not about identifying the time frame then i wont expand on that
grey1

I should have made clear in my opening gambit that we need to focus on setups alone, otherwise the thread will become too far reaching and will lose its way before it even gets started. So, to clarify, let's assume that a large part of the trading plan is complete - certainly each trader has decided upon the type of trader they are, the market(s) they intend to trade and the time frame most suitable for them. Nonetheless, the point Grey1 makes is, IMO, a very valid one and deserves to be explored in another thread. As I say, for now, let's assume we all know the time frames we want to trade. Cheers Grey1.
Tim.

 

[fxmarkets]

yes grey1 but i do see the same setups in different timeframes continually but i get your point, for the sake of all following the same lesson perhaps tim can state an objective timeframe in which to build the lesson upon for sake of objective clarity and ease of following. Expanding to different timeframes and its implications could be looked at when we have clarified an exampled set up in one timeframe.

Perhpas we could go timeframe 5 minute setup with 1 minute fine tune entry. if of course we want to use the 1 minute as entry, I dont know...(plenty of regular examples to work through/charts to demonstrate etc) your call tim.

 

[OpenMind]

Tim, just for clarification, do you intend to discuss the definitions of setups here or the process of defining them?

In other words, are we talking about, let's say for example, the mechanical aspects of a retracement entry setup, or the steps to define one (e.g., start with watching the markets, note the trend, note how fars retracements usually go,...)?

 

[timsk]

. . . for the sake of all following the same lesson perhaps tim can state an objective time frame in which to build the lesson upon for sake of objective clarity and ease of following. QUOTE]

Hi fx,
I don't see the need! Also, why run the risk of alienating swing/position traders who trade off E.O.D. or weekly charts by saying we're just going to focus on 5 minute charts? Each to their own. Whatever your time frame - you need a setup to trade. There must be some process by which every trader arrives at their chosen setup. What is it? As Grey1 implies, it's essential that each trader understands the pros and cons of the time frame of their choice, but I don't think we can encompass that subject in this thread.

Tim.

 

[fxmarkets]

Right tim I naturally assumed that in order to aid discussion leading to learning that an exampled setup, no matter what that turns out to be, could be ,will be shown on an actual security in action.

eg. This is a setup shown on the "daily" timeframe , notice this notice that etc..... but i guess not stipulating a timeframe will lead to people naturally enquiring multiple timeframes .
we will go with what appears and expand from that I assume. and to quote forexhusky. "lets talk !"

 

[Grey1]

There are millions of set ups but the one which I recommend to most traders is as follow.
Please try this technique in real time tomorrow and see its effectiveness

SET UP

lets assume Trader has identified a 5 min as his APPROPRIATE Time frame ..

This set up DOES NOT NEED MARKET DIRECTION .. In another word you wont be needing to watch the market direction for entry .... Some set ups do ( We wont hijack the thread to argue why we dont need market direction .. for the time being we leave it at that Just test the result in real time tomorrow )

LONG SETUP

LOOK AT THE ENCLOSED CHART ..

YOU NEED TO HAVE THREE BARS OPEN ONE AFTER ANOTHER WITH THE FOURTH BAR RETRACING AS CHART ILLUSTRATES

THIS IS YOUR LONG SET UP but you wont go long after the fourth bar soley because you have had a retracement

YOU THEN CHART the same instrument in a LOWER Time frame lets say 1 MIN

YOU LOOK FOR A series of HIGHER HIGHs in THE LOWER TIME FRAME ( BIRTH OF A TREND )

GO LONG IF 1 MIN IN HIGHER HIGH MODE


There are many proven technical reasons for this trade to be sussesssful but i wont bore you with back testing stories ... Try it tomorrow on instrument of your choice .

Once you learn this set up the whole concept of effective STOP LOSS make sence.. ( but we wont hijack the thread again )


----------

FOR SHORT DO OPPOSITE


PS:--

1) this set up happens quite frequently and I invite traders who trade this set up to publish their result after tomorrow in another thread.
2) This set up applies to all time frames and suitable for swing , postion trading

3) you can use the set up to effectively add to your postion each time the series of HIGHER HIGHS repeats or

as soon as the higher high mode reverses with the arrival of new info into the market . ( we donot hijack the thread again )

4) It is VITAL to this set up or any other set up to have the appropriate time frame other wise trader does not make enough $$$ to close his postion ,, Those who coach on this BB should be teaching risk and postion management and how it should be tied to a particular time frame .

5) this set up is rock bottom simple. Nothing complicated about it and you be learing it even more effectively sitting next to a trader

Grey 1

 

[fxmarkets]

Good example grey1 , would i be correct in spotting ma, mah and mal (not visable) on that chart ? to identify break from average range setup ?

 

[dsn]

....and not forgetting to put first things first -

If a setup is a tool to help you get what you want from the market, then you can't define your setup until you've defined exactly what you want.

Sounds obvious, but it's easy to put the cart before the horse and just pick a setup and start defining and testing - only to find after a lot of work that it doesn't give you what you want.

Zoom in by selecting a market with suitable hours and characteristics, a timescale that offers the number/size/duration of moves that suit the trading style you are interested in, then focus on the areas where you would have to enter in order to capture those moves. Then form your setup from what you see there. This can save a lot of time.

 

[fxmarkets]

....and not forgetting to put first things first -

If a setup is a tool to help you get what you want from the market, then you can't define your setup until you've defined exactly what you want.

I have an issue with use of the word "want" as it implies a state of lack, therefore if you want something you will get the feeling of lack associated with the object. If you want something you already have it, ie that feeling of lack for it, or a wanting. On the otherhand if you have something it will flow to you as its a poweful universal statement..

thus if a setup tool helps you get what you have from the market, then you cant define what is your setup until you know what exactly you have.

And perhaps to enlighten Ed Seykota " Everybody Has What They Want"

"I Am" is also a very powerful universal statement.

make sense?

 

[timsk]

As I've said before, and FWIW, there are only three general types of setups: breakouts, retracements, and reversals. Using these classifications to focus saves a great deal of what would be otherwise wasted time and effort
--Db

The title of the thread is 'Setups: Finding, Defining & Testing Them'. If we are all happy with the definition of what a setup is (speak now or forever hold your peace!) - then we can focus on finding -or choosing - a generic setup. Obviously, this is a necessary first step before we can set about a detailed examination of the setup in order to define it more precisely and spot it easily in real time. Clearly, this job will be a lot easier if we know exactly what it is that we're looking for. If we accept db's assertion quoted above, then our first task is to decide whether we want to trade breakouts, retracements or reversals.

Many people are unclear about these terms. For example, what is the difference between a pullback and a retracement? The attached 5 minute chart from last Friday shows BIDU, the new darling of the Nasdaq which, after a meteoric rise 'retraced' to the 38.2% Fib' level. If you were to trade the bounce off this level (at the yellow oval) - would this be a reversal trade or a retracement trade? Without going off at too much of a tangent, would it be helpful at this point to define breakouts, retracements and reversals - in broad terms at least?

Tim.

 

[OpenMind]

If you ask me, it would be a retracement trade. Unless the stock has definitely reversed, we have to assume all counter-trend movements are retracements (or pullbacks: same thing to me). I have taken the liberty to draw a trendline in your chart, probably inaccurately because we cannot see enough in the past.

So the trendline is now broken and we are waiting to see if the stock makes a lower low than B. If it does, the trend has reversed. If on the other hand it breaches A, the trend is still up. A third possiblity is for the stock to oscillate between A and B, which will mean the trend is sideways.

Comments please.

PS. I have found retracement setups the most difficult to define (even loosely). This thread can be a good exercise to achieve that. So thank you Tim for starting the thread.

 

[skinstg]

I have also taken the liberty of drawing a couple of lines on your chart, and my analysis would be as follows:-

The first zone I have labelled between A&B is a bit of a stab in the dark because we cant see what came before, but its a good place to start. Price breaks up through resistance (B), this breakout is then retraced in the zone labelled between C&D (First trendline is also broken, potential trend change is possible).
Price then breaks up again through resistance at D.
By the time price finds support again at E, the next trendline is broken, and again we have a potential trend change. For me the move from F to E would be classified a reversal, as it resulted in a trend line break (Although I have not done much work on reversals).

So now we are waiting for the next move, will price drop through resistance at E, or break up at F - that would be our breakout, and we would then be looking for a retrace of that breakout.

 

[barjon]

...........This, of course, requires definition and understanding of "trend".

--Db

Db

And therein lies the rub.

good trading

jon

 

[barjon]

Db

maybe, but in practice people are likely to be thinking of trend in relation to the particular timescale they are interested in and they are likely to have varying methods for determining whether and when that trend has changed. A lot of variables there to arrive at a tight and suit all definition.

jon