Dissecting a Failed Setup

 | Mar 10, 2013 | 12:00 PM EDT
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Some trade setups play out beautifully. Many others never trigger an entry or simply do not work -- but, fortunately, triggers often filter out setups that will never succeed. Typically, when you are stopped out of a setup, the risk isn't ridiculous compared with the potential reward -- barring a disaster, of course. (Note: I do not recommend keeping setups over earnings, unless they are part of a super-low-risk options strategy.)

CF Industries (CF) -- Daily
Source: Dynamic Trader

As an example, here is an old setup that failed, along with its possible risks and rewards.  This was a time and price setup in CF Industries (CF), using the $211.78-to-$214.33 area and a group of time cycles that were due between Feb. 14 and Feb. 21. If the price had held above this price zone, the upside target would have been the $238.59 area, or the 1.272 extension of CF's swing into that area. 

To see what happened, look at the trigger chart below. The actual low was made on Feb. 15 at $214.47, slightly above the price-support cluster and into the time window for a possible low.

CF Industries (CF) -- 15-Minute Chart
Source: Dynamic Trader

This was followed by a buy trigger: As you can see, a prior swing high was taken out at $216.50, and the eight-day moving average crossed above the 34-day EMA.

Suppose your order got filled at $216.55. In that case, you either would have placed your stop beneath the low that preceded the buy trigger -- or, if you'd wanted to give it a bit more room, you'd have put the stop beneath the low end of the price-cluster zone. If you'd used that first stop, with a buy price of $214.43, you would have lost $2.12 per share. If you had used the wider stop, you would have lost around $4.80 per share. 

If you had used options, the story would have been totally different. On a successful trade, the potential profit would have been to the 1.272 target at the $238.59 area. If you'd bought at $216.55 and exited at the target, that would have meant a profit of around $22.04. The potential risk, therefore, would have been between $2.12 and $4.80, and the potential reward $24.04. That is a very good risk-reward ratio!

* * *

With that, I leave you with a current buy setup in Schlumberger (SLB). The stock has already triggered an entry against the first Fibonacci price cluster zone on the chart below, so you could now enter on a pullback with risk below the $75.72 swing low. The upside potential comes in at the $83.91 area.  If I can fine-tune a pullback entry for you, I will post it this week in Columnist Conversation.

Schlumberger (SLB) -- Daily
Source: Dynamic Trader

Again, not all trade setups will play out. But if the setup has good risk-reward potential, and if you take losses quickly and hold on to winners, you should be able to get ahead of this market game.

With all trade setups, know your risk and your targets. Once an entry trigger fires off, make sure you manage the trade!

For more information on triggers and trades, refer here.

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