Identifying Profitable Setups

WHAT EXACTLY IS A "SETUP"?
A setup means different things to different people. In general, for our purposes, a setup is an area (price or indicator) where a trader would take action; this can be opening a position or closing one. The setup has to meet criteria from price, volume, or any number of indicators being used. Setups can occur at different times of the day or week. For a scalper, setups may appear, one after the other, during a trading day, providing him with many trading opportunities and maybe even make a profit. For a daytrader, these setups may appear from time to time during the trading day. For the swing trader, these setups may appear a few times a week. It all depends on the strategy and indicators the trader uses.

SOME EXAMPLES
Let's take a look at an example. A setup for a stochastic indicator may be to sell whenever the value of the indicator goes above 80%. Conversely, whenever the value of the stochastic indicator goes below 20%, or it is oversold, it may be a setup to go long. In the 15-minute chart of Apple, Inc. (AAPL), the overbought areas, or short setups, are marked with a red arrow, whereas the oversold areas, or long setups, are identified with a blue arrow (see Figure 1).

FIGURE 1: OVERBOUGHT OR OVERSOLD. Here you see an example of a simple setup. When the stochastic is overbought, it's a setup to open a short position. When the stochastic is in oversold territory, it is a setup to open a long position.

If you take a look at Figure 2, you can see that there are five long and five short setups. The number of setups would work well for a swing trader, but for others it may be too few or too many.

FIGURE 2: CROSSOVER OF STOCHASTICS. In addition to the stochastic being in overbought or oversold territory, the crossover of the %K and %D lines of the stochastics can also be used to identify setups.

FIGURE 3: PRICE ACTION SETUP. Once a bottom is formed, it is a setup to open a long position until a top is formed. After you exit that position you can enter a short position when a top is formed.

FIGURE 4: PRICE PATTERN SETUP. Often, setups are formed based on chart patterns. Here you see an example of a price channel. You can create your setups based on when price touches one of the channel lines.

SUGGESTED READING
Swing, Larry [2008]. "Daytrading With The NYSE Tick Indicator," Technical Analysis of STOCKS & COMMODITIES, Volume 26: June.