Sunday, June 17, 2007

Method to Madness II

So, how do you go about structuring your trading? First thing to ask yourself is, what kind of movement are you going to play? Trend following? Trend reversal? Range? This is going to define the kind of setups you are going to look for. Let's try to give some examples.

If you are playing trend following, you are going to look for breakout setups (breakdown too if playing short side, but let's limit it to long simplicity sake). In terms of chart formations for instance, you are going to look for Cup and Handle, JBE, Ascending Triangle etc. If you prefer candlestick formations, you will select those that reflect trend continuation; similarly, with any other study or indicator you want to use, you will be concentrating on those that match your chosen type of the movement. I am staying with chart formations in this example because is easier to envision and this is going to come handy when we finally get to particular setup structure.

If you decide to focus on trend reversal, you will be on hunt for Double Bottom, Head and Shoulders. Finally, if you want to play range, you will look for, well, range - price locked in a certain horisontal limits.

Out of the universe of setups, you will pick several that match your approach. 3? 5? About that, and could be just a couple at the beginning. No point in starting out with 10, you will get lost in their variations. If this step in structuring your trading feels like a small one, it's a misconception. What you just did is a big step: you made a transition from a very general idea (kind of movements to trade) to a very particular thing (exact setups to learn and to hunt for). However mundane the task of matching one to another seems, you would be amazed by how many say they want to trade trend continuation and go ahead looking for double bottoms or tops.

What we are going to do in the next post on this topic is to start structuring our setups - break them down by elements and see how you put those elements together in order to come to a logical, meaningful, structured and controllable way to trade.
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