A Basic Look at How to Differentiate High-Probability from Low-Probability Trade Set-Ups

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Only Take a Trade If It Passes This 5-Step Test

No matter which market you trade – stocks, forex or futures – each second the markets are open provides an opportunity to trade. Yet not every second provides a high-probability trade. In a sea of nearly infinite possibilities, put each trade you consider through a five-step test so you’ll only take trades that align with your trading plan and offer good profit potential for the risk being taken. Apply the test whether you’re a day trader, swing trader or investor. At first it will take some practice, but once you become familiar with the process, it takes only a few seconds to see if a trade passes the test, telling you whether you should trade or not.

Step 1: The Trade Setup

The setup is the basic conditions that need to be present in order to even consider a trade. For example, if you’re a trend-following trader, then a trend needs to be present. Your trading plan should define what a tradable trend is (for your strategy). This will help you avoid trading when a trend isn’t there. Think of the “setup” as your reason for trading. (For more, see: Essential Options Trading Guide.)

Figure 1 shows an example of this in action. The stock price is moving higher overall, as represented by the higher swing highs and lows, as well as the price being above a 200-day moving average. Your trade setup may be different, but you should make sure that conditions are favorable for the strategy being traded.

Figure 1. Stock in Uptrend, Providing Possible Trade Setups for Trend Traders

If your reason for trading isn’t present, don’t trade. If your reason for trading – the setup – is present, then proceed to the next step.

Step 2: The Trade Trigger

If your reason for trading is present, you still need a precise event that tells you now is the time to trade. In Figure 1, the stock was moving in an uptrend for a the entire time, but some moments within that uptrend provide better trade opportunities than others.

Some traders like to buy on new highs after the price has ranged or pulled back. In this case, a trade trigger could be when the price rallies above the $122 resistance area in August.

Other traders like to buy during a pullback. In this case, when the price pulls back to support near $115, wait for the price to form a bullish engulfing pattern or to consolidate for several price bars and then break above the consolidation. Both of these are precise events that separate trading opportunities from the all the other price movements (which you don’t have a strategy for).

Figure 2. Possible Trade Triggers in Uptrending Stock

Figure 2 shows three possible trade triggers that occur during this stock uptrend. What your exact trade trigger is depends on the trading strategy you are using. The first is a consolidation near support: The trade is triggered when the price moves above the high of the consolidation. Another possible trade trigger is a bullish engulfing pattern near support: A long is triggered when the bullish candle forms. The third trigger to buy is a rally to a new high price following a pullback or range.

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Before a trade is taken though, check to make sure the trade is worth taking. With a trade trigger, you always know where your entry point is in advance. For example, throughout July, a trader would know that a possible trade trigger is a rally above the June high. That provides time to check the trade for validity, with steps three through five, before the trade is actually taken. (See also: Pinpoint Entry Points With Filters and Triggers.)

Step 3: The Stop Loss

Having the right conditions for entry and knowing your trade trigger isn’t enough to produce a good trade. The risk on that trade must also be managed with a stop-loss order. There are multiple ways to place a stop loss. For long trades, a stop loss is often placed just slightly below a recent swing low and for a short trade just slightly above a recent swing high. Another method is called the Average True Range (ATR) stop loss; it involves placing the stop-loss order a certain distance from the entry price, based on volatility. (See also: What Types of Investors Are Best-Suited for Stop-Loss Orders?)

Figure 3. Long Trade Example with Stop Loss Placement

Establish where your stop loss will be. Once you know the entry and stop loss price, you can calculate the position size for the trade.

Step 4: The Price Target

You now know that conditions are favorable for a trade, as well as where the entry point and stop loss will go. Next, consider the profit potential.

A profit target is based on something measurable and not just randomly chosen. Chart patterns, for example, provide targets based on the size of the pattern. Trend channels show where the price has had a tendency to reverse; if buying near the bottom of the channel, set a price target near the top of the channel.

In Figure 3, the EUR/USD triangle pattern is roughly 600 pips at its widest point. Added to the triangle breakout price, that provides a target of 1.1650. If trading a triangle breakout strategy, that is where the target to exit the trade (at a profit) is placed.

Establish where your profit target will be based on the tendencies of the market you’re trading. A trailing stop loss can also be used to exit profitable trades. If using a trailing stop loss, you won’t know your profit potential in advance. That is fine though, because the trailing stop loss allows you to extract profits from the market in a systematic (not random) manner. (For more, see: Trailing-Stop Techniques.)

Only Take A Trade If It Passes This 5-Step Test

Step 5: The Reward-to-Risk

Strive to take trades only where the profit potential is greater than 1.5 times the risk. For example, losing $100 if the price reaches your stop loss means you should be making $150 or more if the target price is reached.

In Figure 3, the the risk is 210 pips (difference between entry price and stop loss), but the profit potential is 600 pips. That’s a reward-to-risk ratio of 2.86:1 (or 600/210).

If using a trailing stop loss, you won’t be able to calculate the reward-to-risk on the trade. However, when taking a trade, you should still consider if the profit potential is likely to outweigh the risk.

If the profit potential is similar to or lower than the risk, avoid the trade. That may mean doing all this work only to realize you shouldn’t take the trade. Avoiding bad trades is just as important to success as participating in favorable ones. (See also: Calculating Risk and Reward.)

Other Considerations

The five-step test acts as a filter so that you’re only taking trades that align with your strategy, ensuring that these trades provide good profit potential relative to the risk. Add in other steps to suit your trading style. For example, day traders may wish to avoid taking positions right before major economic numbers or a company’s earnings are released. In this case, to take a trade, check the economic calendar and make sure no such events are scheduled for while you’re likely to be in the trade.

The Bottom Line

Make sure conditions are suitable for trading a particular strategy. Set a trigger that tells you now is the time to act. Set a stop loss and target, and then determine if the reward outweighs the risk. If it does, take the trade; if it doesn’t, look for a better opportunity. Consider other factors that may affect your trading, and implement additional steps if required. This may seem like a long process, yet once you know your strategy and get used to the steps, it should take only a few seconds to run through the entire list. Making sure each trade taken passes the five-step test is worth the effort. (For additional reading, check out: Create Your Own Trading Strategies.)

High Probability Trade Setups: 4 Methods

The Forex market is constantly offering lower and higher quality trade setups. It is our job as traders to scan, recognize, select, enter and exit the ones with the best odds and reward to risk.

The best way is via a strategy. A Forex strategy helps identify setups with a long-term edge because it allows traders to analyze the charts with a fixed process and rules. Traders can tackle the market either via a discretionary or non-discretionary system.

The discretionary method provides the advantage that traders can make a final judgment whether any one particular setup has a decent probability of succeeding. In that way, traders can choose higher quality setups and ignore lower quality setups within their strategy.

This article explains a simple tactic that helps Forex traders recognize the high probability trade setups with help from a few trading setups examples. You can also take our Trader Profile Quiz.

DECISION SPOTS AND TRIGGERS

New information is available on all currency pairs and all time frames every minute. The market is basically in a constant change and each moment offers the potential for a new setup.

Many of these moments, however, do not provide an edge to the trader. These setups do NOT offer a distinct advantage and have a low probability of success.
Setups with a high probability of success have a certain scarcity. The Forex trader must wait patiently for these setups to occur, like a tiger waiting for their prey, and then execute with discipline when the moment arrives.

But how does a trader recognize the moments of waiting and executing?
This is when introducing the concepts of decision spots and triggers are crucial!

WAITING FOR THE LINES IN THE SAND

Decision spots are important and key levels of the time frame of your choice. Identifying decision spots allows traders to ignore price action in the ‘middle of nowhere’ and wait for the price to reach the ‘lines in the sand’. This is critical because setups in the middle tend to be of lower probability and setups at key levels are of higher quality.

Using high probability forex trading strategies has enormous advantages for trading psychology. First of all, it does not cost a trader any money. Most importantly, traders do not have to worry about missing a setup, chasing a setup, entering a setup too soon, etc. It is an enormous help for remaining patient and keeping the discipline needed to succeed in trading. Plus traders can avoid revenge trading by keeping a cool mindset. Taking too many doubtful trades can easily lead to overtrading which leads to a slippery slope where a trader wants to earn back their money quickly.

WAITING FOR THE ACTION OF THE TRIGGER

The trigger is the signal of interest a trader is waiting for. The trader has been patiently waiting for the price to move to one of their decision spots. And now the price has reached it… now what? How and when to trade? This is what the trigger solves. It basically is a call for taking action.
The trigger provides confirmation on how to trade at the decision level. It provides clues whether a trader will go long or short, or in other words whether they will take the break or bounce.

DECISION SPOT VS TRIGGER

Each Forex trader can choose their own indicators, tools, patterns, trends, and support and resistance for the roles of decision spot and trigger. There is no right or wrong method and you should pick something which you like to use and that matches your trading plan and psychology.

With that said, I will now present to you my own preferences for various decision spots and triggers and it is up to you if you use the same.
For decision spots, my number one tool is the strike trigger candle and trend lines. Runners-up are support and resistance, patterns, and moving averages.

For triggers, my number one tool is the candlestick and candlestick patterns. Runners-up are fractals and trend lines.
Here is an example: price is in an uptrend but far from support. After a while, price moves back to the support trend line. The trend line is the decision spot. Price can then show 2 different reactions via candlesticks. Hence the candlestick (pattern) is the trigger:

  • A pin bar at the trend line à a bounce trade
  • A breakout candle through the trend line à a breakout trade (the requirement for avoiding a false breakout: a candle close to a close near the low and most of the candle through the candle)

Traders can use different tools and indicators for each of the two roles. The above is just an example but one I use often for my own trading.

“SWEET” SPOTS

The best opportunities, which we name “sweet” spots, are areas where the strong confluence of levels exists AND wide open space is present.

  • Confluence zones are actually the best decision spots available because it increases the probability of a trade setup succeeding. This happens because more support or resistance is available in that decision area, which makes the decision spot more valuable compared to decision spots with no confluence (see an example of confluence in the screenshot above).
  • Wide-open space is the potential movement price can make after reaching the confluence zone upon a break or bounce before hitting another decision spot. The more space the better as it allows the trader to have more options regarding exits.

Other sweet spots can be identified by using the concepts of impulse and correction. Price is always in either of the two and it depends on the strategy for which one is better for you.

For my own trading, I prefer catching the completion of a correction, the middle of an impulse and also the start of the impulse. I try to avoid trading the end of the impulse, start of the correction, and the middle of the correction.

Conclusion: I use the concepts of decision spots, triggers, confluence, and wide-open space to judge the best and highest probability setups.
Do YOU use decision spots for your trading setups?

How do YOU set up triggers?
Thanks for adding your opinion here below.

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A Basic Look at How to Differentiate High-Probability from Low-Probability Trade Set-Ups

Day trading is fast, fast, FAST. If you don’t know what you’re doing, you can kiss your capital goodbye.

Before you enter any trades, you must know when to enter the market, when to buy, and when to sell. But that’s not all …

When buying and selling stocks and assets in a short period of time, you also want to make sure you know how to identify trends, patterns, and entry points. This can help you minimize losses and increase your chances of reaching your trading goals.

That’s where day trading setups come in.

What are setups? How can you use them in your own trading? Let’s take a look at the wonderful world of setups now.

Table of Contents

What Is a Day Trading Setup?

You probably already know that day trading is the practice of purchasing securities during a short window of time, normally in rapid purchases throughout a single day.

Traders respond to small price movements in stocks and indexes, aiming to buy at a low price and sell at a higher one.

The goal of day trading is to secure quick profits. Purchased stocks are owned by a day trader for usually no longer than a few minutes (sometimes seconds) before they are resold.

A day trading setup, also known as an entry strategy, helps you identify trading opportunities, trends, and entry points.

Smart day trading setups require efficient technology, which you can update over time. While it’s possible to day trade using just a smartphone, a more sophisticated setup involves a reliable computer — either a desktop or laptop (like these sweet systems).

A high-resolution monitor can also be very useful when maintaining a high-level view of stock movements. (Check out our guide to trading monitors!)

Benefits of Using a Day Trading Setup

In this world, some things you need to know include patterns, price action, and recognizing the difference between long and short trades.

When you know these things, you make better-informed decisions and take strategic action. So, with the right setup, you can reduce your trading anxiety and boost productivity.

What’s not to like, right? Here are a few setups that rank high among many day traders’ favorites. You might learn that you prefer other setups, but this is a good starting point to introduce you to the idea …

4 Favorite Day Trading Setups

Because there are a variety of trade setups, it’s important to choose the strategy that best suits your trading style. The better you understand and connect with a particular setup, the more likely you are to see results and improve your day trading process.

The following four setups can help you manage risk and allocate resources. Mastering just one of these setup techniques can help you trade with more confidence — and hopefully better results.

1. Day Trading Breakout Setup

The breakout trading strategy is popular among many traders, from professional to beginner.

The breakout is ideal for monitoring potential losses because you can often see immediately when you’re making a wrong decision. And in trading, you always want to cut losses quickly!

Another appealing aspect of breakout trading is that the techniques and principles involved can be applied to all securities on the market, from stocks and Forex currencies to bonds, commodities, and cryptocurrency.

In breakout trading, you first need to identify a price level, which represents your breakout trading level.

Day traders move into the market once they see that a stock price breaks beyond that defined range. After this break, you close the stock above resistance level. This is known as “support and resistance.”

KALY chart: Breakout Source: FreeStockCharts.com

When it comes to buying and selling, aim to buy when the market breaks above a failed resistance level, and sell when the market breaks below a failed support level.

Another form of breakout trading is known as “swing high and swing low” breakouts.

It works in a similar way to support and resistance. However, in this case, the breakout trades happen only with the setups that indicate the best potential returns. On a chart, you look for a “V” shape, which indicates a strong rally and is followed by a strong selloff.

The downside: When you scan the market for possible breakouts, you’ll likely encounter false ones at some point. Also, breakout trading requires skills like the ability to assess whether a support and resistance breakout will hold or fall. If you’re not comfortable doing this, don’t make the trade!

To avoid these false breakouts as much as possible, you can use a technical indicator, such as a volume-weighted moving average (VWMA). This indicator is useful because it analyzes volume, not just price.

You also have a few options when it comes to acting upon a breakout. You can either wait to buy it, or anticipate the breakout by building a strong position. Each option carries different risks and potential outcomes. Always do your research — and lots of it — before you trade.

Considering the allure of potentially instant returns coupled with the excitement of surfing stocks’ momentum, you can see why breakout trading is such a popular technique.

Now let’s take a look at ranges …

2. Trading Ranges Setup

A range-bound trading strategy focuses on sideways price action, and stocks that swing back and forth between two prices after they’ve stopped following a certain trend. These are referred to as a “range-bound” stocks.

Fun fact: Range trading is especially popular among forex traders.

The range trading strategy takes advantage of the percentage of the market that is non-trending. For example, if the market only trends 30% of the time, then this leaves 70% of the market to experiment with.

Trading ranges also consider support and resistance. Why? Because support and resistance levels are created when price oscillates.

First, you’ll need to confirm that price range to make sure the price doesn’t break above or below any point in between the highs and lows. At least two similar highs and lows need to have occurred in this price oscillation for it to be considered a range-bound setup.

One of the trickiest parts of range-bound trading is finding those two points against which to trade — that essentially represent support and resistance levels. Your example chart here shows range trading over several days.

CWCO chart: Range Trading Source: FreeStockCharts.com

Unlike many setups, trading ranges don’t offer the opportunity to ride a stock trend — but the highs and lows involved can be relatively predictable.

So once you get the hang of them, trading range-bound securities could be a great strategy for you.

There are many complex strategic approaches to range-bound trading, but the simplest method is to buy near the support level and sell at resistance. You don’t want to find yourself on the wrong side of the breakout, so be sure keep an eye out in case this occurs!

It’s important to note here that tracking trading volume is just as important as watching support and resistance patterns. At the end of the day, range trading involves making a purchase based on the presumption that a price will fluctuate between certain highs and lows.

Many traders use indicators such as relative strength and commodity channel indexes to help them place their trades. These can help better identify the entry or exit positions of support and resistance.

Now let’s talk flags …

3. Trading the Flag Setup

Flag patterns are relatively easy to recognize on charts and follow straightforward strategies.

As the name suggests, being able to identify flag shapes on a price chart is part of the setup. The way that the flag is “blowing” indicates the direction of the primary trend, and represents a stock going through a strong uptrend.

The flag shape formation is a result of a stock that made a strong move upward, on high volume (forming the pole shape), and then consolidating at the top of the pole, on lighter volume, where the flag is formed.

CANB Chart: Flag Pattern Source: FreeStockCharts.com

This trend continues when the stock breaks out of the consolidation pattern — once again on high volume.

To identify a strongly trending flag, look for patterns with less than 23.6% retracements.

Flag patterns always stay above the 23.6% threshold. You place your purchase on the break of the high.

It’s also important to watch for impulsive moves which have little to no retracements.

Flag trading can follow a momentum trading strategy, and these stocks are normally traded on two- and five-minute time frames. It isn’t just a day trading setup either; it can also be applied to swing trading.

If you’re looking for simple trade setups, flag trading could be right for you. However, identifying the flags can sometimes be tricky. Fortunately, with the help of a scanner, you can often quickly find the stocks that are surging and then consolidating to form the flag shape on the charts. Once the price has broken out above the consolidation pattern, on high volume, that’s your time to strike.

Clearly, volume is a key element to look out for when flag trading, as it confirms the pattern when it happens at the right moment. You want to jump on board when the volume comes in on the breakout!

There are several types of flag patterns, like bull flags and bear flags. The main differences are that the flags trend in different directions, upside, and downside.

Flag trading is widely considered to be great for new traders because once you understand them, they can be easy to spot and trade on.

Flags are generally small chart patterns, which means they tend to carry less risk than other day trading setups and can yield potentially pleasing results.

Now, last but not least, it’s triangle time …

4. Triangles Setup

Triangle trading occurs with highly volatile stocks that pause, giving you the chance to figure out exactly how you’ll trade it before it starts to move again.

Once you find a volatile stock that’s worth trading, consider trying the triangle day trading technique.

The main objective of the triangle day trading setup is to catch the profit as the price is moving away from the triangle.

For a triangle to occur, you need a minimum of two swing highs, and two swing lows, which are both connected to trendlines which extend to the right. Your example chart here shows a bull flag with triangles over a few days. It’s not perfect, but you can see the triangles to a certain extent — this is more realistic anyway.

FRLF chart: Bull flag with triangles Source: FreeStockCharts.com

There are three different types of triangles (symmetric, ascending, and descending), but they’re all traded according to the same breakout strategy.

Always make sure that strong movement and volatility precede the formation of the triangle, then draw the trendline once you see the triangle pattern forming.

With the triangle setup, you buy below the most recent swing low and sell above the most recent swing high.

Many pros recommend searching for triangles during lunch hour in the U.S. because it’s a time when volatility typically declines, allowing triangles to form before volatility picks back up again.

Another fun fact: Potential profit is always calculated based on the triangle height.

If you’re interested in triangle trading, try it with a paper trading account first. It’s never a bad idea to hone your skills by placing stop losses and quickly calculating targets before you start trading on real capital.

When using a triangle setup, remember that your target — as with all trading in general — isn’t an exact science. A good rule of thumb: Aim for a reward outcome at least twice as much as the risk involved in making a purchase.

Key Points to Keep in Mind With Day Trading Setups

1. Follow Chart Patterns

Before you set out to find great trading setups, it’s crucial that you become familiar with reading charts and identifying chart patterns.

While we, as traders, can never predict price action with absolute certainty, once you start gauging historical price action from chart activity, you’re taking steps to avoid risk, and can potentially increase your reward probability by placing the right trades.

So whatever day trading setup you decide to follow, make sure you’re confident in following chart patterns, whether it’s a triangle, flag, or otherwise.

Trade with the trend — it’s an age-old adage, well-known by all traders.

Identifying trends (like support and resistance) in chart patterns is necessary for all day trading setups. To avoid risk and unnecessary losses, keep it simple and trade with the trend!

Determining trends and identifying when they end are all skills you’ll — hopefully — learn as you gain trading experience. Learn them.

3. Stick to Your Trading Plan and Indicators

Your trading plan defines which stocks, assets or securities you plan to buy and sell, which day trading setup you’ll follow, and which resources you’ll use to keep you on track.

Without a solid trading plan, you shouldn’t even bother trading. It’s that important. Learn to create a trading plan now.

If you switch between setups and change your plans mid-trade, you’re in for trouble. Stick to your plan. And if a trade starts working against you, get out immediately.

Also, be sure to take advantage of your indicators. They’re there for a reason and can help you to identify crucial trend lines and directions. Use them!

4. Use a Great Stock Screener

No matter what type of trading account you have, it’s important that you find the best trading opportunities each day — to do that, you need the right software.

Check out the StocksToTrade platform to see why many of the best traders in the world begin each day by loading up our platform.

StocksToTrade is a one-stop-shop for your order entry, charting, watchlists and newsfeed needs. If you’re ready to start trading at a higher level, get a 7-day trial of StocksToTrade for $7 now!

The Bottom Line

Trading setups are awesome. They can improve your ability to read charts, identify patterns, and understand trends and entry points in the market.

Try out different setups and see what works best for you. Once you get into the swing of a setup that works for you, see how far you can go to perfect your technique …

… You might be surprised by how far it takes you!

What are your favorite trading setups — and why? Leave a comment below and tell us about it.

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