A 1, 2, 3 Method for Quantifying Trade Ideas

Apr 7, 2007: 12:22 PM CST

Do you feel overwhelmed with opportunities when you complete an evening scan of your charts?

Adopt a simple quantification method to separate trade ideas into three categories for increased possibility of action, and decreased confusion.

This method assumes that you scan various charts either on the evenings or on the weekends, and are looking for key set-ups based on an individual trading system. This also assumes you find too many possibilities to narrow down into actionable trade ideas.

You will need to develop this idea as your own, but the guiding principles include ranking any chart patterns or trade set-ups into three categories:

Tier 1 Ideas:

Set-ups that you identify as triggering immediately, and you need to enter the trade the next day.

This might include pullbacks to key moving averages or support zones (in a trending stock), or rallies into resistance you identify that you want to enter a short trade. This also might be an indicator reading turning up out of oversold and indicating a direct buy signal ripe for the taking the next morning.

Tier 2 Ideas:

Set-ups you identify as forming and developing, and will likely trigger for entry within 2 – 5 days.

This is when you see a neutral reading in an indicator on its pathway to oversold (or overbought) that will soon signal a buy (or sell) signal related to your system. It might also indicate a trend thrust (impulse) you missed, but want to enter when the stock retraces to a set zone where you desire to be a buyer, and you want to enter the trade WHEN this happens.

Tier 2 Ideas are deserving to be in your watchlist with entry zones listed, or conditions listed that – when triggered – will move up to Tier 1 Ideas to be entered.

Tier 3 Ideas:

These would be general market structure identification where you would like to keep a stock in your watchlist to grab your attention when it sets up a trade entry signal based on your system. These might include strong stocks in strong sectors in an uptrend that are just now consolidating in range that offer no discernable trading opportunity, but you like the previous price action or the core fundamentals of the stock you desire to trade.

Your goal with these is simply to continue scanning them until they give buy signals based on your system. Just because a stock has a great story or good fundamentals does not make it a trade candidate until it signals a set-up based on your system/strategies. You should give these the least attention in your scans, but not drop them from memory or your watchlist because – in the future – you will anticipate trading this stock when it conforms to your system or signals.

It is not enough to keep one watchlist and believe that you will capture all the opportunities you are seeking. It is frustrating to keep a great watchlist and be overwhelmed by the possibilities and rush yourself into trades when you should have been patient and selected the best candidates for immediate price performance.

Dividing your opportunities into (at least) three watchlists – ranked by immediacy of possible price action – can help you narrow down to the highest probability moves while allowing yourself opportunities to enter new trades when they trigger should your tier 1 ideas result in a stop (or loss). This also keeps you engaged in the market and analysis, and continues to sharpen your skills.

Your goal in trading is to simplify the process and cut down on the multitude of decisions, so that you identify and execute the highest probability trades according to the system you have developed for yourself.

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