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Trade Setups vs. Active or Actionable Trade Ideas

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Trade Setups vs. Active or Actionable Trade Ideas

To expand on the front page post that I published earlier today, I just wanted to clarify the difference between a Trade Setup and an Actionable or Active Trade (whether official or unofficial).

A trade setup is a security that appears to be setting up in a bullish (or bearish) chart pattern or technical posture, such as tapping against a downtrend line after a prolonged uptrend during a consolidation period, ideally with bullish divergences forming on the indicators. A trade setup is only a potential trade candidate, pending a buy (or sell) signal for a long (or short) entry. No buy (or sell) signal, no trade. As I often say, support is support until & unless broken just as Newton's First Law of Motion states that a body at rest will remain at rest unless an outside force acts on it. As such, a stock in a downtrend testing a trendline from below may continue in that downtrend for quite some time, regardless of how oversold (technically) or undervalued (fundamentally) the stock may be.

In trading, the catalyst for that 'outside force' is often a breakout of a well-defined level of resistance (or break below support), such as the uptrend line that defines the top of a bullish falling wedge pattern. Taking it one step further, breakouts that occur on average or below average volume have an increased rate of the breakout failing vs. breakout that occur on 1.5x or greater average volume. I find that this holds true more so on long-side (bullish) breakouts than short-side (bearish) breakdowns but either way, the higher the volume expansion on the breakout, the better the chances are that the breakout will stick. I will typically use the 60, 90* or 100*-day average volume (*preferable) of the security in that calculation, any or all of which is provided by nearly all brokerage trading platforms.

To calculate the where the volume on a stock or ETF is tracking at the time of a breakout, the following formula can be used: Volume of the security at the time ÷ number of hours elapsed in the trading session × 6.5 (number of hours in a trading session) . For example, if XYZ stock triggers a breakout at 12:30 pm EST with total volume for the day at 1,000,000 shares at the time, then the stock would be tracking to do a total daily volume of 2,166,667 shares. (1,000,000 ÷ 3 × 6.5 = 2,166,667). As such, if the 90-day average volume for that stock at the time is 1.2M shares, then the stock is tracking about 1.8× or 80% above the average daily volume at that time.

One factor to take into consideration when estimating the tracking rate of the volume on a security is that volume patterns on stocks & ETFs, as well as the indexes, typically takes the shape of a smile when viewed on an intraday chart, such as a 1-minute period chart with the largest volume bars at the open & close, gradually tapering off after the open down into the midday session & then gradually rising into the close from there.

While there aren't any guarantees that confirming a breakout with above average volume will assure that a trade will play out successfully, waiting patiently for a stock to trigger a breakout, ideally an impulsive breakout on above average volume will help to shift the odds in your favor.

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2019-01-11T12:13:27+00:00Jan 11, 2019 12:11pm|Categories: Trading Tips|1 Comment

One Comment

  1. rsotc January 11, 2019 12:22 pm at 12:22 pm

    I have a bad habit of proofreading my posts until after publishing them, if at all. Just caught my typo the time of day used in that example of calculating the tracking volume for XZY. I had left out the ‘2’ in 12:30 am so the copy of this post sent out by email will incorrectly read 1:30 instead of 12:30. That typo has been fixed above although notifications sent by email to members of the site will not reflect corrections of typographical or grammatical errors, as those are sent immediately upon publication.

    Also, note that many front page posts will receive comments & replies related to that post from myself & others that will often trickle in over the next few days or more. As such, I would encourage anyone that is interested in the content of a particular post to periodically visit the site to check for comments & replies to that post.

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