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Keep drawdowns small

Posted on 1/31/2014


When market goes in to volatile times like these ( of which there was clear warning for last few days), always think about drawdowns.

Drawdowns are motivation and time killer. And volatile periods can quickly lead to big drawdowns.

There are people who thrive in these kind of conditions. But if you are not that kind of a person just watch the game.

If you get in to say 5% hole it will take you time to recover. If you just lose 1% or 2% or not even that , you are in better situation.

When the conditions improve you are positioned well.

I worry a lot about drawdown . Ideally I would like to make money with less than 1 to 2% drawdown. I am already up for the year and in capital protection mode to preserve that gain. 

While I am looking for money making opportunities , I am not terribly fond of periods like these. You should trade when easy money is available. 

Know this equation well
image

Big moves need big surprises

Posted on 1/30/2014

Last night Facebook (FB) earnings were released and the stock was up double digit in after hours and is likely to open up 18% from yesterday. Earnings surprise lead to this move.

FB is a stock that had big earnings surprise in August 2013. We bought it in Working People Portfolio on the earnings breakout. Subsequently added January 70 strike 2015 LEAPS to the position. The position is still open in Working People portfolio.


Working People Portfolio Open Positions

While on day to day basis I look for short term swing moves of 8 to 20%, I also look for big trades that can make the year. 

Finding big moves like this requires different kind of skill.

Stocks need no catalyst or just a minor catalyst to make 8 to 40% move. Such momentum burst require no special skills to trade once you understand the basic mechanics of swing trading. 

Trading big moves requires understanding of catalyst and growth investing . Most big moves start with a big surprise. 

When a stock makes 100 to 1000 % move , there is always an identifiable catalyst behind these moves. 

Most common catalyst that can lead to explosive multi quarter or multi year moves are:


  1. big Earnings growth
  2. big Sales growth
  3. big orders
  4. big shortages (especially in commodities sector)
  5. big govt policy changes
  6. drug trial or approval news in drugs/biotech sector
  7. big management change
  8. big turnaround in business
  9. big activist investor move
  10. big sector move
These kind of big moves in stock are precipitated by some sort of an Episodic Pivot. Episodic Pivots are significant events in the lifecycle of a stock that results in significant re evaluation of the future prospect of the stock. If you search this site you will find detailed discussion on how I daily look for such Episodic Pivots in systematic fashion.

If you want to find big moves like FB right at the start of their  move look for big surprises daily. One or two trades like these can make your year. 



Find something that is structural

Posted on 1/29/2014

Find something that is structural in nature of the market.

As a trader your task is to find some structural phenomenon to build your edge around.

It should exists in the market and not figment of imagination.

If you find structural edge it will last decades.

What are some of the structural things in the market:

1 Market moves in momentum bursts

2 Momentum stocks outperform non momentum stocks

3 longer term momentum is mean reverting

4 Surprisingly good earnings leads to rallies

5 News leads to immediate moves

6 small cap/small float outperform larger stocks

7 lower priced stocks outperform higher priced stocks

Now if you know any of these you can build your trading around it.

Structural edge is something that has been tested thousands of time and has been around for hundeds of years. 

Swing trading using momentum bursts

Posted on 1/28/2014

The basic structural phenomenon behind most ideas discussed on this site is " Stocks move in short term Momentum Bursts"

It has been observed and verified that stocks move in momentum bursts during bullish periods in indexes (bull markets).

During "established" downtrend (bear markets) in index they show same phenomenon on the downside. They go down in momentum bursts of 3 to 5 days.

In this kind of momentum burst move in a stock , the first day is  range expansion which is immediately followed by follow through.

The sequence looks like:

Range expansion day

Up day (follow through)

Up day (follow through)

pullback

followed by end of momentum

That  is the bullish sequence. Variation can be 5 day burst. In rare cases you will get a 8 to 10 day burst.

Sometime it will be variation of the 3 days with inside day or negative day after first day of range expansion.

There are many possible variations but essentially this is an impulse move of 3 to 5 day duration. 

During this 3 to 5 days period stock would go up 8 to 20% ( lower priced stock can even have bursts of up to 40%).

Such bursts may or may not have clear identifiable catalyst. You need to know nothing about the company to trade this kind of burst.

This is a pattern and probability based trade.

It is largely mechanical way to trade for small profit targets. 

(To find stocks likely to go up multi month or year I use other methods. They are also discussed in detail on this site. Just see the sidebar for some of the popular posts)

Move starts with range expansion

All such momentum bursts start with a range expansion. The first day of the move is range expansion day. Often there is also volume expansion along with range expansion.

The price moves in the direction of range expansion. 

When there is range expansion it attracts breakout traders, it attracts other momentum players, day traders, quants and so on. That results in continuation of move for few days.

Range expansion basically means a day which is up bigger than last 5 to 10 days bars. A range expansion preceded by series of range contraction days is good candidate in this setup. Moves preceded by orderly range contraction can be explosive.

A successful momentum burst will lead to immediate follow through. Say a stock breaks out in the morning, it will continue to go up through the day and will have immediate follow through in next 2 to 3 days. And the follow through should also be of big 4 to 5% plus magnitude on second or third day.

In most cases the momentum dies down in 3 to 5 days.

If you keep holding after the 3 to 5 days period, you would often see the stock ends up giving up all the burst gains and may not have another momentum burst for several weeks or months. Sometime the burst gains vanish intraday itself.

Depending on price of the stock such momentum bursts can be of 8 to 40% magnitude. Lower price stocks tend to make bigger moves.

For a stock trading below 5 dollars a breakout day move itself might be of 10 to 20% magnitude. For traders with small accounts that offers good opportunity.

As a practical matter if you have large amount of capital to trade with it is difficult to grow your account by just focusing on these low priced stocks. You might have to buy lots of 50000 to 100000 shares for meaningful difference to your account.

Lower float stocks make bigger moves. Low float and high demand creates explosive moves.
If you see in any year the most short term explosive moves will be on extremely low float stocks. For those with smaller account size there is distinct edge in trading low float stocks.

No specific catalyst is needed for these momentum bursts.

Why do these moves happen?

In some case there might be a specific news catalyst on day of first range expansion day , but in vast majority of these kind of momentum moves, there is no clearly identifiable catalyst.

However tracking news on daily basis might help you enter some of these momentum bursts very early and magnify your profit.

During bull moves in overall market such momentum bursts have been observed for over 100 years.
This is structural nature of market.

You should be independently able to verify this.
@mhp a member on Stockbee.biz site  also posted a backtest with 3 day hold period after range expansion on timeline to show how this works historically.

Here is a profit line from taking up to 6 momentum burst longs per day for the past 10 years, 1000 shares per trade, using simple mechanical rules. As per his backtest.

image

Stocks seldom run up or down smoothly.

A 30% move in stock over 3 months in a stock might be completed in 2 momentum bursts of 10 to 15% in just 5 to 6 days. Rest of the time the stock might retract or go in range.

In a year you will probably find 5000 to 10000 such 3 to 5 day setups when both bullish and bearish setups are combined.

Momentum burst kind of swing trading allows you to grow your account with very low risk.

For a mere 3 to 5 day exposure to market you capture the most explosive part of the move and you are not seating in dead periods holding stock waiting or anticipating a breakout which may or may not come.

Trading this kind of setup requires extremely good ability to ruthlessly cut losses if a trade does not work immediately .

It also requires skill to exit when things are still in explosive phase and not wait for reversal.

Per trade profit on these kind of trades will be on an average just 5 to 8% as you are only going to get part of the 8 to 20% move. By the time you enter on breakout day the stock might be up 4 to 10% , so you will not be able to capture that part of the range expansion move.

To trade this kind of setup you need to be willing to do 200 to 1000 or more trades in a year.

You make money by compounding these small gains.

So this is high frequency and low per trade profitability method.

There are periods in market where these kind of setups are prone to failure.

This happens near market turns where in short period lot of breakouts fail.

The bullish breakout trade needs to be avoided during fast selling phases in market.

The bearish breakdown trade works best after a downtrend is clearly established on 10 plus day time frame.

In a bull market trading 3 day bearish setups will lead to lot of failed breakdowns.

Because of the nature of the overall markets (they have significant positive bias), there are in number terms more bullish momentum bursts than bearish momentum bursts.

Once you understand this momentum burst based short term phenomenon, the next task becomes how to trade it by setting up proper procedure for it.

There are many ways to do this. Traders like @mhp trade it completely mechanically and have shown long years of profits.

His system is completely mechanical and based on custom developed software and execution tools.

Traders like me trade the method using discretion. I do not take every setup. I use some well defined criteria to only try and buy good quality setups.

There is extensive discussion of this on this site and the scans and steps I use are detailed here multiple times. I use Telechart to do this but people have replicated same thing in various other softwares.

Methods and philosophy

Serious damage to many high flyers

Posted on 1/27/2014
What  difference couple of days can make.

Number of momentum favorites are under selling pressure. Stocks that had orderly uptrend have had high volume breakdowns. Many have lost a month or more worth of gains in 2 to 3 days.

This is where flexibility helps of individual traders. At the first hint of trouble you can close all long positions and don't have to seat through phases like these. Unlike funds you don't have to be fully invested all the time or have constrains of liquidity to sell in to.

A market correction like this is not a surprise after 15 to 18 months of rally. During that rally all corrections have been minor and had just one leg. They were followed by V shaped recoveries.

The V shaped recoveries were big problem for short sellers as they found it too painful to get out. Let us see if that happens again. If it does not happen in next few days we will be set for nice volatile correction.

Typically in these kind of correction once the fast selling phase is over some select longs work and good short setups show up.

Welcome back individual investors

Posted on 1/24/2014

This was on front page of IBD couple of days ago. The TD Ameritrade CEO was going gaga over how the individual investors are back in full force now that market is up several montha in a row.

We had a discussion on members site about it and we discussed how it is time to really protect open profits and not get cocky and keep one eye on quick exit. I made 2 videos warning people to not get carried away.

Extremely good momentum does not last forever. If you go to the Market Monitor tab on this site and see the column


When the readings go above 20, it is a sign of excessive bullishness. It invariable leads to correction.

This time there was a bit of delay in selling hitting after it went up. But invariably this is what happens.

Seen this movie for 14 years .... I know how it always ends....

People get mesmerised by excessive momentum and forget where there cap is while looking at vertical moves.

By the time they realise what happened not only their cap but clothes are also missing....

And as to those individual investors who very excitedly entered the market now, well the market is teaching them nice lesson in how to be a bag holder....

Welcome back individual investors after missing a big rally. 

The bags are in right corner. You can take as many as you want. 

When breakouts fail


LM was a trade I entered on breakout and next day got stopped out with small loss of 1.4%.

Breakout failure in momentum burst is something I am not afraid of. It is very much part of the game. Ugly failures like LM happen. There are out many ways to avoid them.

The trick is in good risk management . In LM trade I had 20% of account invested, but my risk was only .25%.

Risk = entry-stop

So the trade not working resulted in just .28% loss on overall capital (.28 due to slippage as I exited few cents below stop)

Trading momentum burst is a probability and number games. Over large number of trades the winners and losers can e equal but if the winner has higher profit than losses on the losers you come out ahead.

Last year only 50.5% of my trade in this method were profitable but the winning trade produced more profit than losing trades.


If you have that kind of equation then it becomes a game of doing sufficient number of trades to get good returns.

Even if the ratio is not 2.21/1 you can still make lot of money with lower ratio provided you make sufficient trades.


That 1.62/1 ratio still produced 73.75% return for the year.

Sometime one large uncontrollable loss making  trade can skew the averages. Let us say you had close stops and the stock gaps down, you end up taking more losses than you planned for.

In an ideal world I would like to enter a no losing trade and have a stop as close to entry as possible , but that is not how this particular setup works.

One of the things you will notice if you trade this kind of setup is that at market turns or correction areas you become vulnerable to losses.

When you play a momentum trading style , sudden shift in momentum like we saw yesterday can result in lot of breakout failures.

That is part of the risk involved in trading momentum.


Trading is a performance sport.

Trading is a performance sport.

You have to actually trade to see how things work, just knowing does not make you money.

When you read a trading book or watch video or subscribe to a site you might get an idea on how to trade but unless you can perform it yourself it is of no use.

Performance can be learned in many ways, but all the ways involve something which you can not avoid. And that is actually performing the act hundreds of time and getting it right every time.

If you perform say 500 trades using momentum burst method you will develop performance skills. It will become effortless. You will know the intricacies of it.

A basketball player, tennis player or golf player any other player is in same category. What they indulge in is in performance sport. Knowing how to serve a top spin and watching how to do it on Youtube and reading a book about it will not even qualify you to become a ball buy.

And then the individual investors  think they can trade knowing nothing or by just trying few things. It does not work that way and it will not work and it has not worked for hundreds of years.

Yet come January lot of individual investors will attempt it , they will try it for few weeks or months and give up. How many of the people do you think will persist till say March or June. Even if they persist how do you think will do.

One of the first starting point of performance sports is you need equipment and facilities. You can not play tennis unless you have a tennis racket and court to play on. You can not be a golfer unless you have clubs and golf equipment.

Same way you will not be able to perform as a trader or investor unless you have proper trading tool and broker and willing to pay for it.

In the beginning of every year I get lot of emails from newbies or individual investors who want to get into the game. The first advice I give them is first get the right software and broker.

Some understand that , majority do not. They want to as far as possible avoid paying for a software or use proper broker. They will go to great length to try and find a way around it. They feel it costs too much.

Which to a large extent is fallacy.

The same people spend over 100 dollars on their cellphone or pay 100 dollar or more for TV service for sitting on their butt and 100 dollars or more per month  for their kids or spend more in many other services without blinking an eyelid. But don’t want to spend 20 to 30 dollar on data service for trading.

Or look for some shitty brokerage service that offers them free trades.

There is no polite ways to tell these people that you are unlikely to ever make it in investing or trading unless you are willing to spend for basic things. It is like trying to play football without having a football.



Performance skills have another attribute to them. There is a degree of complexity involved in them. And you need to start at right level and build from that level before attempting highly complex thing.

Every year in my daughter's dance class they have a dance show performed by dads of the girls called Dancing Dads. Dads spent around 6 months preparing for this with weekly practice and more frequent practice closer to the event. The dance teacher tries to keep things as simple as possible so that amateurs can do it easily.

Inspite of that it takes serious practice and commitment to do those basic things. She constantly supervises individual dancers. Corrects the flaws. Shows steps hundreds of times. If someone is struggling she spends special time doing it with that person multiple times.

All performance skills are like that.

If you understand and appreciate it that it is performance skill then you will also set your goal accordingly. You may want to win the Olympic gold medal in Tennis , but if you do not have right equipment and skills you will go nowhere.

I get lot of beginners asking me they want to be position trader. Wow! Great.

Why . Oh I am very busy in my office or business and I don't have much time.

Seriously think about this.

If investing and trading is performance skill and you want to learn it and you are going to do it only 3 to 5 times in a year (position traders hold positions for long time and have very few trades in a year), what are your chances of success.

It is like saying I don't know much about golf but I just want to participate in Masters and the Ryders cup.
You can dream about it but it is not going to happen.

To learn to trade if you do 100 to 500 trades your chances of learning performance are high. If you do it 3 times in a year , there is not going to be enough learning to correct your own mistakes. You can not win or come anywhere closer to winning a tennis match by serving 3 times in a year.

In order to learn to be a position trader start by doing basic simpler things like trading a week or few weeks swings. Master that first and then graduate to next level.

Those who understand that will be around till year end rest of the enthusiastic beginners will be out by March or even earlier.

Performance skills like trading can only be learned by performing them , watching others perform them and emulating them, and by constant coaching to improve performance.



Range contraction and range expansion

Posted on 1/22/2014

LM: Leg Mason Inc. 

One of the basic tendencies of markets is that periods of range contraction or low volatility are followed by periods of range expansion or volatility implosion.

To anticipate a breakout you have to scan for or identify stocks in range contraction or low volatility phase. From that stage the stock will eventually breakout in either direction. In case of LM it was a bullish breakout. It offered a low risk entry point.

Long running trends have series of such range contraction and range expansion periods. This offers swing traders several opportunities for swing trades.


Path to expertise development

Posted on 1/21/2014
Most of our understanding of experts and how their memory works  is gained from study of chess players. 
Study of gifted chess players has shown that preparation plays a big role in their development. A good chess player has accumulated knowledge of 10000 plus past games and actual experience of playing thousands of games. 
Deliberate practice is key strategy used by chess players to develop their skills. They play everyday. They constantly recreate past games. They constantly practice. They study others games. 
Back in 1985, Benjamin Bloom, a professor of education at the University of Chicago, published a landmark book, Developing Talent in Young People, which examined the critical factors that contribute to talent. He took a deep retrospective look at the childhoods of 120 elite performers who had won international competitions or awards in fields ranging from music and the arts to mathematics and neurology. Surprisingly, Bloom’s work found no early indicators that could have predicted the virtuosos’ success. Subsequent research indicating that there is no correlation between IQ and expert performance in fields such as chess, music, sports, and medicine has borne out his findings. The only innate differences that turn out to be significant—and they matter primarily in sports—are height and body size.
So what does correlate with success? One thing emerges very clearly from Bloom’s work: All the superb performers he investigated had practiced intensively, had studied with devoted teachers, and had been supported enthusiastically by their families throughout their developing years. Later research building on Bloom’s pioneering study revealed that the amount and quality of practice were key factors in the level of expertise people achieved. 
Buliding on Bloom's work in 1993, a researcher named K. Anders Ericsson published a paper called “The Role of Deliberate Practice in the Acquisition of Expert Performance” were he developed a general theoretical framework for the development of expertise by examining the development of expertise across a variety of different domains to see what commonalities arose. Most of our understanding of expertise development is based on this seminal study. 
This kind of deliberate practice results in development of ability to think in chunks. Studies show chess players can look at a board and remember large number of moves compared to novice. Not only that they can work out several more moves and anticipate moves compared to novice. 
While to play chess innate talent is needed, the deliberate practice builds the skill several fold.
The momentum burst setup is a purely pattern based play. Under certain circumstances stocks make a sharp 3 to 5 days move. By deliberately studying several thousands of the past setups we are trying to develop expertise in identifying good setup in real time.



If you study thousands of these setups you will find not all lead to explosive moves , but if certain underlying conditions are present like nature of pre b/o consolidation and low volatility prior to breakout , then it leads to explosive moves.
Most of you after reading about the setup and looking at few of them, intellectually believe that yes a setup like this exists. The challenge really is to put an effort and do deliberate practice to a level where you understand and internalise the setup like a chess grand master and play it in real time.
Challenging yourself to go through at least 100 to 1000 past setups like these depending on your work commitments is the path to expertise development. 
If you are genuinely motivated that should not be a problem. It takes an hour to go through 400 to 500 setup once you get a hang of it.

LGIH the kind of setup I like

Posted on 1/17/2014

LGIH is a recent homebuilder IPO with good growth. It has been climbing up nicely since IPO. Today it has a range expansion. 

Prior to the range expansion it had very orderly sideways consolidation of many weeks. A narrow range day before range expansion day.  Series of narrow range days in consolidation.

That is the kind of setup I look for. 

Buy range expansion at the beginning of a swing







Buy range expansion at the beginning of a swing. That is the essence of swing trading. Swing trading tries to capture part of a trend move or a range move. If you buy at beginning of swing you can sell near end of swing.

Buy range expansion after a period of 5 to 10 day consolidation and an orderly consolidation. Orderly consolidations are low volatility periods where buyer and seller at equilibrium. Buy range expansion preceded by low volatility period. A range expansion from that phase indicates fresh buying pressure. 

Buy range expansion after a negative day. A range expansion preceded by a negative day indicates start of a fresh swing.

Buy range expansion after a narrow range day. Narrower the range better it is. Narrow ranges often lead to explosive moves on range expansion.Buy range expansion after a series of narrow range days. That is even better.


Buy range expansion if stock is not up 3 days in a row. As a swing trader, if you regularly buy stocks up 3 days in a row , you are likely to sooner or later blow up your account. The Professional trader buy on first day of the swing as soon as range expansion is signalled. Second day follow through id driven by residual buyers, newsletter followers or slow reactors. Third day is when many novice notice the move and get excited. the professionals sell in to that euphoria. They are happy with their 8 to 20% profit in 3 days and the third day buyer becomes the bag holder.

Buy range expansion early in a trend. Say a stock is rang bound for 3 to 6 month and then it breaks out then that is a young trend. Buying proper momentum burst setups in these your trend first or second or third time works . But same stock when it is up say 6 month and trading near its high and all time high at some stage buying a extended move on that kind of stock will likely hasten your death as a trader. Even if you have to trade those kind of extended moves , ensure extremely good risk control and position sizing. As trends get extended they can become vulnerable to swing failures.

The most important thing to remember as swing trader is that always buy range expansion at beginning of swing move. That one rule can make you millions and save you lot of heartburn.






Methods and philosophy

There is a structural phenomenon in the market

Posted on 1/16/2014

There is a structural phenomenon in the market that has been observed on both bullish and bearish side for hundreds of years, that when stock move , they move in sharp momentum bursts of 8 to 40% that last 3 to 5 days.

RESI is an example of this kind of momentum burst move in last 2 days. It came in range expansion scans 2 days ago early morning as it started to have a range expansion.  Stock went up 16% in less than 48 hours. 


If you want to find and trade moves like these you need to know certain things about these momentum bursts moves:

Stocks move in momentum bursts of 3 to 5 days on both bullish and bearish side

Stocks move in momentum bursts of 8 to 40% magnitude depending on price of the stock.

Stocks can give you 4 to 20% gains in 3 to 5 days during momentum burst (half of the 8 to 40% burst move)

Stocks move in momentum bursts of 5 to 50 dollars if they are high priced stock.

Stocks move in momentum bursts and no specific catalyst is required for this momentum burst.

Stocks move in momentum bursts even if they have poor or no earnings or poor or no sales.

Stocks move in momentum bursts irrespective of either being value or growth stocks.

Stocks move in momentum bursts near 52 week high

Stocks move in momentum bursts near 52 week low

Stocks move in momentum bursts near all time high

Stocks move in momentum bursts near all time low

Stocks move momentum bursts in bull market the and magnitude of momentum burst is big

Stocks move momentum bursts in bear market but the magnitude of momentum burst is small or lesser number of stocks make those burst moves and follow through might be low.

Stocks move momentum bursts in bear market to the downside.

Stocks move in momentum bursts on news day.

Stocks move in momentum bursts in the absence of news also.

Stocks move in momentum bursts in anticipation of news.

Stocks move in momentum bursts post good or bad news.

Stocks move in momentum bursts on Monday

Stocks move in momentum bursts on Tuesday

Stocks move in momentum bursts on Wednesday

Stocks move in momentum bursts on Thursday

Stocks move in momentum bursts on Friday

Stocks move in momentum bursts if the market is open.

Stocks move in momentum bursts and some bursts can be anticipated and entered with very low risk.

Stocks move in momentum bursts and you don't need to know anything about the company to profit from that.

Stocks move in momentum burst and first day of that move is a range expansion day.

Stocks move in momentum bursts and to find and trade these kind of momentum bursts all you need is simple range expansion scan and good understanding of swing trading techniques. 

Methods and philosophy


How to become good at trading a setup

Finding a good trading setup is just one part of the task. Most things that work in the market are in public domain and if you are slightly motivated you can find several readily available setups that work. 
But becoming good at trading a setup is where the rubber meets the road.
There is no magic blue  pill which will make you good at trading a setup. It might cure your ED, but it is not going to make you money using a setup.
Many beginner traders and even established traders will every year buy several books, attend courses, go to bootcamps and many times disappointed. They expect to become good at trading a setup by attending few hours of course or read a book. 
There is simple reason why it does not work. It is called procedural memory.
Unless you spend hours and hours going through past examples and looking at how the setup looked on breakout day. 
How it progressed. 
Which one worked why. 
Which one failed and why. 
What was the profit in 3 to 5 days. 
What happened after that. 
Where should you have entered. 
Where should you put stop. 
Where and on which day should you exit. 
If I am going to use sell stops or trail how should I manage it.
Ten thousand hours of that kind of dedication will make you good swing trader.
 Are you man/women enough for that kind of effort...
If you are not stop trading , put money in index fund and forget about it or find someone else who can trade for you and give him or her enough incentive....
and if you actually put in tens of thousands of hours you will develop life long skil which you can take to your grave.... That is your best retirement scheme...
Choice is yours.

How to identify the A quality setup

Posted on 1/14/2014
There is a very specific range expansion pattern we are looking for when trading momentum burst.


When you start running scans in the morning like 4% scan or $ breakout scan , you are throwing a wider net. It catches few good fish and lot of marginal or extended setup. The key is to be extremely clear about what you are looking for and not get excited by each and every breakout.


If you see the Timeline from yesterday or last one week or from last one month you will see that there are various levels of skills in identifying the setup. There are veterans of the site who have been around for years and they know exactly what they are looking for and they pounce on good setup in an instant.


At the other end you have novices in trading the setup and they often select wrong stocks. They have not spent sufficient time developing skill to instantly identify the setup.


What are we looking for


We are looking for a momentum burst lasting 3 to 5 days and that is preceded by a 3 plus days of period where there was no momentum burst .


The example below shows an ideal setup we are looking for.


When a stock goes up a lot after breakout the optical illusion creates a picture that can be slightly distorted and you feel the stock traded extremely narrowly pre breakout. That is why I have shown below the exact same stock and set up on breakout day.



What you see on the breakout day is a 4% breakout on high volume. Preceding that breakout for 17 days the stock did not have a momentum bust . During the 17 days it did not also have 4% breakdown. In 17 days prior to breakout it ha series of narrow range days.


Essentially this stock was  consolidating pre breakout. The breakout triggered a mini buying frenzy and stock went up for next two weeks. We are interested in setups like this. This is an ideal example of setup but in real life you find a slight variation of this basic setup idea.


Look for the quality of a setup


Do not get into the habit of buying marginal setups. Wait for a A quality setup to show up. Better quality setups allow us to put logical and tight stop and they work instantly.


Here is another  example of a good setup and how it would look on breakout day.



Look carefully at this set up and read my guidelines for finding best setup. Does this setup meets them.


  • stock should have range expansion on breakout day
  • volume on breakout day should be higher
  • day before breakout should be narrow range day or negative day
  • pre breakout there should not be many 4% breakdowns
  • stock should have linearity in prior action
  • correction or consolidation should be orderly
  • volume during consolidation should be preferably orderly
  • stock should close near high on breakout day
If you internalise the guidelines you would instantly recognise good setup from marginal one. More importantly if you religiously do the daily setup exercise I post, in few weeks or months you should be able to identify these setups even if someone wakes you up in the middle of the night and asks you to identify good from bad from a list of 20.


How did the above stock look on breakout day



Does it meet all our requirements. It traded in narrow range pre breakout . It had low volatility pre breakout. It traded linearly in previous move and this was a very compact orderly correction. On breakout day volume was higher.


Anticipating a breakout


Once you get good at trading these kind of breakouts you can focus your energy on identifying these kind of setups pre breakout. That allows you to anticipate a breakout and either enter in anticipation or put an alert and enter as soon as price exceeds certain level.


Anticipation of breakout requires working from some kind of pre screened watchlist to narrow your focus. I assume you do not have time to go through 8000 stocks daily in Worden universe and find these.


There are many ways to narrow the universe so that you look at only say 50 or 200 stocks to anticipate a breakout. But that is a topic by itself.


Look for A quality setup


A good setup works like a charm. When we select marginal setup or settle for second or third best it results in frustration.


To identify these kind of setup you have to understand this is a skill which requires some minimum level of competency. You develop that by correctly identifying setups after setups. For that you need to study historical setups. The other option is to attend the Stockbee boot camp where we spend considerable time on these things so that by end of the two days you can instantly recognise these setups and how to trade them.

Don’t settle for marginal setups. Always look for the Victoria’s Secret model. If you can’t find her don’t settle for Hanes model.

Methods and philosophy