IDENTIFICATION OF TRADING OPPORTUNITY
I want to go deeper into this topic which we already discussed. Purpose of this post is to offer an algorithm of trader's action, describing each step and bringing structure in the chaos.
First stage is apparently identifying the basket of stocks to watch.
Two major criteria should be applied:
1. Activity
2. Possible setup.
Speaking of first, you want to go where activity is, and this leads you to watching pre-market gaps and volume.
Second is a little bit more complicated as you try to find the situation which MIGHT create opportunity but it's possible that activity isn't there yet. Doing this you have to determine your stop point in advance, for the case if action never occurs or stock is doing opposite to what setup looked like.
Let's go through first approach in more details.
You spotted the action - what is next?
Next step is to identify the type of the action. This is very important stage for the following reason.
Action might be such that you never see any familiar setup that would give you reasonable trade. There are plenty of movements that we can't utilize to any "trading" extent as opposed to "gambling" extent. What I mean is:
If you put on the trade because you see the setup you are trading. If you just go for the action not seeing setup - you are gambling.
You might lose on "trading" trade and you might win on "gambling" trade, but in a long run you are to lose if you go for pure action without any attempts to identify the setup.
When trade shows familiar situation that's where you get probabilities on your side.
It often creates the situation where you sit and wait in spite there are plenty of hot movers around. You have to ignore everything that moves in a way not allowing you to read the movement within your system.
So, the process has two stages now:
1. Spotting the activity
2. Identifying the type of activity.
Next stage is defining of scenarios in terms: IF - THEN.
It goes like this:
you see for instance stock approaching higher limit of the range and your setup is buying of breakout because you identified the trend of the stock as uptrend and are going to buy the high, going with trend.
Your set of scenarios: (those are just examples, not describing of strategy)
- buying at 20 - I buy
- IF pullback to 19 5/8 THEN I get stopped out because 11/16 was the support on last pullback.
- IF movement over 20 THEN I move my stop to 19 3/4 because stock shouldn't drop that far if it's really strong.
- IF stock moves to 20 3/8 THEN I move my stop to breakeven.
- IF stock moves over 20 5/8 THEN I sell half and move stop to 20 1/4 on remaining half.
- IF stock moves up too fast on big volume THEN I sell entire position.
Note that scenarios built in such a way that any kind of market action triggers certain reaction of yours. It goes in accordance with our general approach: let market tell you what to do.
After your set of scenarios is done you have pretty much "programmed" behavior and it becomes your psychological support. You already predetermined your stop level and assumed the risk, so if stock acts nasty it doesn't come as surprize for you. It's merely one of scenarios. Knowing that you were not to predict anything you take it calmly and in in cold blood.
If stock goes in your favor you know what to do next and there is no room for overexcitement and all those "Go ABCD!!!" which show unprofessionalism.
As stock moved in your favor another set of scenarios kicks in. It involves moving your stop up and selling of half of shares as you secure your profit or selling it in full if you are scalper or if the trade was intended as scalp from the very beginning.
After trade is closed you get back to monitoring and looking for activity. Full cycle is completed and now it's time for new cycle.
As a daytrader you spend much more time on sideline sitting and waiting for the right opportunity to present itself.
You are filtering out everything that:
1. Doesn't fit your risk criteria.
2. Moves in a way that doesn't allow you to identify familiar setup.
3. Sets up but still doesn't trigger the trade.
3 means that AMZN went to 32 1/2 where it should be a short
but selling never hit this level. Oh well: trade was not triggered.
You can often see Chris or me saying:
to enter ABCD long we want to see fast selling under 18.
Stock never sells down and we don't make any call on it. Why? As you could see, sometimes it goes up from 18 1/8 and it might look like missed opportunity. We ignore it for one simple reason: bounce from this level without fast selling prior was not what we can read within our system. Either we see the setup or we let it go. Trade outside of setup is gambling.
This program of your action is very important as it brings the structure in what seemed to be chaos. You structure your own behavior putting some kind of algorithm in it.
Eventually that is what disciplines you and creates favorable environment for getting rid of emotional disbalance. When you act within predetermined scenarios you don't let the action to trigger your ego intervention. Ego raises its head when you expect stock to do something, and stock does opposite. If you don't expect anything but are ready for any turn of events, nothing wakes ego up.
Attempts to jump on everything that moves lead to inevitable
frustration as stocks act randomly for a trader doing this.
They couldn't act any different because he was looking at them randomly, and he was taking the trades randomly.
As soon as trader has formed certain system which is nothing more than set of setups and scenarios, where setup is trigger for the action and scenario is algorithm of action, his behavior ceases to be chaotic and moves from gambling to trading.
Vadym
RealityTrader.com |
