NEW TECHNIQUES

Beyond Setups

by Steve Palmquist

There are several aspects to trading beyond your trading setups. Here's a look at five factors that will help you become a better trader.

Like most professions, trading requires a number of different skills to be successful. It takes time to develop these skills - two to five years - and there are few shortcuts if you try to do it alone. Many traders will read about a system and use it until they have a number of consecutive losses. Then they switch to another system in a constant search for something that works all the time. They will continue to lose money until they realize there is more to trading than just setups. Some traders will use very tight stops trying to minimize risk. When they lose most of their money, they become convinced trading is just luck. Some traders use only a single system they learned from an expert, and eventually, when they start losing with that system, they wonder why it doesn't work anymore and stop trading.

The school of hard knocks has taught me that there are aspects to trading, beyond setups, that successful traders must master. Here are five of the six factors to trading better (I'll tell you the sixth later):

TRADING WITH THE MARKET

Learning to read the market and trading with it is one of the keys to success. Many traders read a few books, open an account, then start reading the luxury-car and yacht brochures. In late 1999, that was about all it took. Back then, almost any system worked, and it wasn't unusual to make $10,000 several days a week in relatively small accounts. When the market turned in 2000, many traders discovered that understanding the market is only one of the key skills needed to succeed. They learned the hard way that they had to be guided by the market, not the opinions or hopes of others. They learned that no system works all the time. And they learned that it is critical to know the market conditions favorable to each system you use.

I monitor the Nasdaq for market guidance because it generally leads the other indexes on both the up and down moves. The market has three types of behavior: trending up, trending down, and basing. Trendlines are key tools for determining what the market is up to. As long as the market is above an ascending trendline, focus on trading long setups. When the market eventually breaks below the ascending trendline, it enters a period of uncertainty; it may base for a while or enter a new downtrend. During periods of uncertainty, risk increases, so reduce position sizes and use the short-term techniques in your trading toolbox.

If the market makes a clear lower low after breaking an ascending trendline, then a new descending trendline should be drawn and traders focus on short setups until the descending trendline is broken to the upside. If the market enters a basing period, the trader's actions should depend on the width of the base.

Excerpted from an article originally published in the November 2006 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2006, Technical Analysis, Inc.


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