How to Identify Trading Setups - Phemex Academy (2024)

Summary

• A trading setup refers to a certain “arrangement” of price bars that point to possible favorable outcomes when trading, signaling a good time to enter or exit a trading position.
• The most common types of trade setups are breakouts, continuation, range and reversal patterns.
• There is no such thing as the “best” trading setup; three factors that should be taken into consideration when establishing one’s ideal trading setup are risk tolerance, time availability and size of trading capital.

What is a Trading Setup?

A trading setup involves a particular configuration of price bars that point to possible favorable outcomes when trading. Trading setups are used to indicate when it might be a good time to enter or exit a trading position. These setups work because they are deeply related to market psychology, displayed in the form of different signals such as bars, candlestick patterns, and overall price movement of assets.

How to Identify Trading Setups

1 Study chart patterns

Traders use various technical indicators to try to predict the price movement of an asset. Of course, this can’t be done with any certainty. That’s why reading chart patterns properly is crucial to executing a successful trading setup. Trading charts show the historical price performance of assets, and they can help spot patterns and trends in the overall price movement of a particular asset.

2 Spot market trends

Trends are another key component of a good trading setup. Trends reduce the amount of time spent analyzing charts because they show the likely price movement of an asset. They also cut down on unnecessary risks and losses. Learning to spot market trends is a thing that comes with trading experience, so people should expect to spend some time trading before they can become proficient at spotting trends.

3 Use suitable trading software

Regular success in trading requires having the appropriate information on hand always so as to be able to execute trades on time. This is where the right trading software comes in. Trading software can be configured to show only the information needed for a person’s style of day trading setup–some of this information includes watchlists, newsfeeds, and charts.

4 Enough patience to stick with your trading setup

No trading setup is guaranteed to succeed every time, even when followed properly; a significant part of trading is luck. However, trading setups do help to increase one’s odds of success.

Unfortunately, trading setups won’t work if the user doesn’t have enough patience to stick with them. If a person abandons a trading setup the moment things go south, then they might never get to know what works and what doesn’t. Having said that, there are times when a trading setup should be abandoned, such as when a trading setup seems to yield no results by a given time frame.

4 Types of Day Trading Setups

1 Breakout trading setup

Breakout trading is a technique that aims to capitalize on every market trend. It involves heavy use of technical analysis, particularly support and resistance. Breakout traders aim to buy when an asset falls below a particular resistance level, and sell when the asset goes above a support level.

Charting support and resistance levels for breakout trading setups (Source: Axi)

Support level refers to the point where a downtrend is expected to pause temporarily due to increased supply while resistance levels refer to points where uptrends are expected to pause temporarily because of increased supply.

The benefit of breakout day trading setups is that momentum favors traders. Breakout traders can usually see when things go bad (or good), and this allows them to plan their entries and exits quickly, allowing them to minimize losses or maximize gains (however, traders should also be wary of false breakouts.)

2 Range trading setup

Range trading involves entering trades that are expected to have a sideways-price-action. Sideways price action means the price of the asset stays within a particular range for a given period. The price doesn’t go higher than the previous high, and it doesn’t go lower than the previous low.

Establishing setup for range trading over a time frame (Source: www.ig.com)

Range day trade setups usually do not ride trends. Range traders focus on the chunk of the market that’s not trending. Range trading is usually drawn over a certain time frame. However, they are traders who apply range trading setups in intra-day trading. The highs and lows in range trading are quite predictable. This makes profiting from range trading a bit more consistent. However, such profits tend to be generally smaller per trade.

Range traders also make use of support and resistance levels but they are harder to spot for day traders. There are several range day trade setups including, rectangular, diagonal, continuation, and irregular. Tracking trade volume is very important in range trading.

3 Continuation trading pattern setup

Continuation trading patterns are patterns that indicate a tendency to continue a present trend after the completion of the pattern. Continuation patterns can be strong or weak depending on the trending waves that preceded them. There are several types of continuation day trading setups, all depending on the shapes are formed by the price chart. Some types of continuation patterns include:

• Triangles: Triangles are formed when price becomes increasingly compressed. Triangle patterns usually involve higher lows and lower highs, which form the shape of the triangle when both resistance and support lines meet. There are different types of triangle patterns including ascending, descending, and symmetrical trading setups.
• Pennants: A pennant day trading setup usually consists of a large upward or downward price movement, followed by a short-lived price consolidation, and a continuation in the same direction. Sometimes, pennants signal traders that the market is taking a mini pause before a breakout.
• Flags: Flag trading patterns usually involve short-term trend reversals that follow a medium to longer term price trend. Flags tell traders that a previous trend might continue after a short-term countertrend. Flags can also indicate breakouts after some price consolidation.

Identifying bullish and bearish flag patterns for continuation trading setups (Source: Forex Academy)

4 Reversal trading setups

As the name implies, reversal trading setups indicate that a trend might be about to end. Spotting reversals help traders know appropriate times to exit a trading position. They can also signal new types of trades since reversals usually mean a price break is going to happen and a new trend is about to start.

Reversal patterns that occur at market tops are called distribution patterns where more people sell the asset than buy it. Reversal patterns that occur at the bottom of markets are called accumulation patterns because more people buy the underlying asset than sell it. Some common examples of trend reversal patterns include:

• Head and shoulder patterns
• Double top patterns
• Double bottom pattern
• Quasimodo pattern
• Sushi roll pattern

Which Is the Best Day Trading Setup?

The best day trade setup depends on a trader’s preferences. The factors considered by traders when selecting a trade setup include:

• Risk tolerance: High-risk traders tend to have higher potential rewards. However, they also have a higher risk of failure. Using stop-loss and stop-limit orders helps to manage risk in trades.
• Time availability: Some trade setups are more favorable during particular time frames because more traders are likely to be active during those times. Keeping time zones in mind is particularly necessary for day trading, especially for those that focus on trends.
• Size of trading capital: The total amount of capital available for trading (i.e. money you can afford to lose!) should also guide a trader’s strategy. Some trade strategies tend to have more consistent but lower returns, while others give large but sporadic returns.

How to Set Up a Trading Desk

For many who are looking to get into active trading, a suitable desk trading setup is necessary. Active trading requires staying abreast of the latest market information as well as short and long term price trends.

For this reason, knowing how to set up a trading desk is necessary. Trading desk setups should be easy to navigate and should display all the necessary information used in your trading strategies. Before knowing how to set up a trading desk, a person needs to know the crucial elements of a trading desk setup:

1. Height-adjustable standing desk
2. Multiple screens for displaying charts, wish lists, indicators, and newsfeeds.
3. Ergonomic chair
4. High-speed internet connection