3/04/2010

Why setup selection is key to decreasing cognitive load


Sometime back I made a post New traders and cognitive load this post is continuation of that post....



If I have to give one advice to a new trader, it would be to hunt for a setup. All successful traders trade a setup or a bunch of setups. They have skill specific to their setup. Setup is a set of conditions used to enter and exit a trade.
Successful traders have vast expertise on trading a very niche setup. For example if you go to Charles Kirk site, there are lot of nice things he does , he makes great link posts, he gets good guests, he does good job of finding interesting stuff,  but forget all those things, at the heart of his method is a ATR channel based setup. That setup is critical. If you can understand that you will be able to make lot of  money. What does Charles do, he scans stocks based on some technical and fundamental factors and then he enters or exits them using a set of conditions. He knows and is experienced a lot in his setup and that is why he makes money. 
Same way if you go to Dan Zanger's site you will see that he specializes in 2 or 3 setups. His favorite is bull flag. Same way if you study any successful trader they have a setup they trade. That setup works for them.
The problem for beginner trader is that as a beginner you will not understand the importance of a setup. Because there is no manual or book which tells you that the key to trading is to find setup. Any expertise is task specific. So defining a specific task to become an expert at is very critical.The first step in becoming a good trader is to arrive at a tradable setup. And then become an expert in trading that particular setup. It is a very microscopic skill.
What is involved in developing a setup is you start with broad concept or start with setup that has worked for someone else and then make it work for you. For that you have to go through a versioning process. You refine and refine a setup till it works. This is a iterative process. For example I trade a very simple 4% breakout setup. That setup has evolved over a period of years. Starting with a setup idea I picked up in The Hedge Fund Edge by Mark Boucher, I refined and refined the idea till it evolved in to current setup. 
On that particular setup I have very narrowly focused expertise. Because I have thought about it a lot and have gained lot of experience of trading it, I see things in the setup that someone will not be able to see. 
The task for novice trader is to go from their current stage to a level where they have a setup which works for them and suits them perfectly. You will have immense confidence once you reach that destination. Once you can make a setup work, then it is easier to make other setups work or develop other setups. 
I constantly look for setups and study other peoples setups. You will see most successful traders do the same. Sometime back I had coffee with one of the members who is a day trader. We sat in Dunkin' Donuts and talked for 5 hours. Guess about what. Setups. Not about economy or how evil is Goldman Sachs or how market is manipulated. As against that couple of weeks ago I had coffee with a beginner trader and all he was obsessed about was irrelevant macro issues. 
Whenever I visit a blog or people send me request for linking I always look at what is this persons setup. If I find a good setup I study it. I may not use it, but it gives you ideas. 
So if you are a trader looking to progress your trading further think setup.
Once you have a setup your problem of cognitive load will decrease because you will be doing a very narrowly focused task. Once you find your own setup you will be able to shut out environmental noise.

Next: Look for an efficient setup





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