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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


rmike said...

"Always look for the Victoria’s Secret model. If you can’t find her don’t settle for Hanes model"
:) :)

I suppose, for someone who's just beginning to earn his 'pants' in the arena, even the Hanes might look like manna to cover the essentials (pun intended ;)).

Hi Pradeep, good to see you donning the mentor cap again to begin the new year in right earnest with great insights for the stockbee blog community!

To add to your post, it may be helpful to build up an 'anticipation watchlist' for potential momentum bursts by looking at those stocks which have had one such prior burst with a shallow pullback (in the range of 10 to 20% from the previous burst's high) and are undergoing volume as well as range contraction (many ways to code that depending upon the user's belief and preference).

Wishing you a great 2014!!!

Pradeep Bonde said...


Unknown said...

Hi Pradeep,

How does your scanning work in real-time? From what I can see, your indicator is showing when a breakout has occurred. However, one wouldn't know for sure that the breakout has occurred until the close of the candle (i.e. the end of the day). At this point, the swing has already started.

If I ignore the indicator, would you enter on a 4% breakout at the start of the day? And if so, does that mean that in some trades it doesn't close as a 4% breakout at the end of the day? How do you handle this?

Thank you!

Pradeep Bonde said...

I enter most breakouts in first 30 minutes. If they reverse then get stopped out