Here's My Formula For Success in Trading

 | Jul 02, 2018 | 3:00 PM EDT
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How do you make money using technical analysis?? Well you wait for the trade setups where you have a perceived "EDGE" in the market. The edge is essentially an advantage over other traders. The EDGE exists if you are patient and you follow a successful trading plan that has been back tested.

I can give you an opinion on where I think the market might go, but that opinion by itself has no value. It ONLY has value if I can back it up with definition of risk and potential targets. Otherwise how would you know when it's time to ditch the trade or take a profit?? I actually have a FORMULA for success in trading. It is called STEM. It stands for SETUP + TRIGGER = TRADE ENTRY and then MANAGE.

For me a trade setup is based on Fibonacci ratios on the price axis of the market. This will often coordinate with some key information on the time axis of the market too. It is better when both time and price analysis come together at the same time, though price by itself is a trade setup.

My setups include:

  • Fibonacci price clusters which include the coincidence of at least 3 Fibonacci price relationships within a relatively tight range.
  • Symmetry setup - only 1 symmetrical projection in the direction of the trend is needed for this setup, though it can include more than 1.
  • Two-step pattern setup - this is also a price cluster with the coincidence of 3 Fibonacci price relationships, but in this case it is a zig-zag pattern with specific ratios that I want to see within that pattern. The specific parameters for this setup are clearly described in my book Fibonacci Trading.

When I see a trade setup that is tested and it essentially holds above the support for a buy setup, or holds below the resistance for a sell setup, I go to step 2 which is looking for a trigger. A trigger is essentially price action that tells me it's worth placing a bet against the setup zone in question. For simplicity sake, let's discuss a buy setup as an example.

Let's look at this setup example from this week in S&P Futures. This was a price cluster setup that came in between the 2687-2696 handles. Besides the price support, I also had timing cycles that also told me to anticipate a possible low. The most obvious cycle on this chart was the fact that the decline into the recent low lasted 11 trading days. This was exactly the same as the 11 trading day decline into the May low. This time symmetry is illustrated on the daily chart below.

 
 

Now since the time and price support was tested and not violated, the next thing I needed to do was look for a buy trigger. For a swing trade, I like to use either a 15 or 30 minute chart to trigger an entry. In the chart example below, I'm showing you a trigger on the 15 minute chart.

For a buy trigger I like to see the 8/34 ema crossover. This is when the 8 ema crossed back above the 34 ema. I also want to see a pattern shift. I want to see it shift from a bearish pattern of lower lows and lower highs, to higher highs and lows. So for a buy I need to see a prior swing high taken out which shifts the pattern. This is also illustrated on the 15 minute chart below.

Once I saw the trigger, I had the option to buy the S&P then, or fine tune an entry buying the pullback after the signal fires off. The maximum risk on this setup, (part of the management) would have been defined below the 6/28 low. The S&P rallied 52.25 points from the original support zone before I would have exited with a trailing stop. Now of course you can not expect to get the full 52.25 points, but if you get something in the middle, it is a successful trade. Now if you don't want to trade futures outright, you can buy the SPY etf. Another option is to use vertical spreads in S&P futures options for a bullish strategy against parameters like these.

 
So the setup was the price cluster on the daily chart.

The trigger was on a 15-minute chart. (We want to use a lower time frame chart for a trigger so it triggers relatively close to where the risk is defined.)

Once the trigger fired off, that was my alert to enter the buy side of the market.

Once I entered the trade it was time to manage it with an initial stop and then a trailing stop. Another option is to exit at a specific target. For now, I'm not going to discuss the details of the trade management. I'll leave that for another article.

STEM...... It's a way to extract money from the markets.

(This article originally appeared on Real Money Pro at 10:06 a.m. ET on July 2. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and many others.)

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