How to qualify a trading setup?
This is a critical step, a milestone, in the discovery process of your own trading system, a system that is right for you, that you will be able to trade effortlessly once you are ready. The setup is a key building block of the trading system.
It takes a lot of work, you may need to to practice like Patton's soldiers, but here is a specific action plan I followed, and I will follow for new setups I am learning to trade:
Action plan to qualify and learn to trade a setup:
- Read a lot about this setup or patten. Search for it, on investopedia, on stockcharts, on forex factory and beyond. Read Joe Ross book law of the charts, it is free.
- Learn and understand this setup or pattern. What does it mean? What is happening in the market when it is being printed. Why it is supposed to work? Who feels fear and who feels greed? Where the unfilled orders are if this pattern is printed on the chart? Where the stop losses are? Read dr Alex Elder book "Trading for a living" to understand the trading psychology behind technical analysis patterns.
- Learn and decide how you would trade it. Where would you place a stop loss? Where is the entry order? Is this a limit, stop or market order? (entry method)
- Find it on historical charts. Find 20+ occurrences of this pattern on historical charts. Note down what happened next. How it would be good to trade it. Find occurrences that paid and ones that did not pay (would end up in a loss). Take screenshots, copy them and review.
- Backtest it. scroll back without looking and go bar-by-bar (F12 in MT4) and look for the pattern. Imagine you are trading this. Note the result. Do at least 20 trades. Are you profitable? If not, repeat and learn, possibly adjust the approach. Yes, it is a lot of hard work. It is more like weeks vs. hours. Use a trading simulator.
- Forward test it. Once you are profitable trading this pattern bar-by-bar on historical charts with no cheating, move to demo. Trade it on demo for at least 20 trades, but I'd recommend 40-100. Use equal dollar risk per trade position sizing so that results are not randomly impacted by a trade size.
- Checkpoint. Are you consistently profitable on demo? Do you trust in your ability to trade this pattern? If you said yes to all of the above
- Start trading it live on a micro account. Set a position size to lose a small equal amount per trade. Trade it for 3 months or 40 trades at least, whichever comes last. Analyze your performance on myfxbook. You can start a journal on forex factory to stay motivated and get inputs from others. Important note: to start trading you need to qualify the complete trading system, not just the opening setup. See other building blocks.
- Gradually increase your position size. If you are profitable on micro, slowly increase your trade sizes and keep trading and learning. Over time, if you are successful, add new systems and test them the same way, withdraw some profits, diversify your savings.
Is this all? No. I covered the trade opening setup qualification here. You need to follow a similar path to learn how to close the trade effectively, how to use confluences and filters and how to apply the right position size, i.e. other building blocks of the trading system.
As a result, you will be trading with high quality, and you will be consistently profitable if you have a profitable trading system and trade it with quality. And this is what we are after!
One last point, if you think now: "OK, I can do this, but what setup should I learn to trade?" or "just give me a profitable system and I will do it", my answer is: you can try my SDH1 EOD system that I trade, however I do not know if it is the system right for you. You can also read trading books or Forex Factory trading systems forum. Unfortunately no one can do this work for you. Everyone needs to discover their own trading system or method.
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