Do you want to find high probability trading setups?
I’m sure you do, right? (Or you won’t be reading this right now)
But the thing is…
…you’re not sure how.
Instead of looking at price, you’re looking at indicators (without understanding the purpose of it).
Instead of following trends, you’re trying to predict market reversals.
Instead of proper risk management, you put on a huge bet because this trade “feels good”.
If you’re doing any of the above, then it will be difficult to identify high probability trading setups.
But don’t worry.
I’ve got good news for you.
Because in this post, I’ll teach you step-by-step on how to find high probability trading setups.
Here’s what you’ll learn:
- Why trading with the trend increase your returns and reduce your risk
- How to identify the best areas to trade on your chart
- How to trade pullback, breakouts, and the failure test pattern
- How to set a proper trading stop loss so you don’t get stopped out “too early”
- A high probability trading strategy that lets you profit in bull & bear markets
Are you ready?
Then let’s begin…
The definition of the trend is this…
Uptrend – consists of higher highs and lows
Downtrend – consists of lower highs and lows
If you want to know where’s the path of least resistance, look left (and follow the trend).
When the price is in an uptrend, you should stay long. When the price is in a downtrend, you should stay short.
By trading with the trend, you can see that the impulse move (green) goes much more in your favor, compared to the corrective move (red).
Here are a couple of examples…
Now you’re probably wondering:
Rayner, identifying a trend looks easy. But how do I enter an existing trend?
And this is what we’re covering next…
Trade in the direction of the general market. If it’s rising you should be long, if it’s falling you should be short. – Jesse Livermore
You’d probably heard of the saying, “buy low sell high”.
But the question nobody asks is…
…what’s low and what’s high, right?
This is where Support & Resistance comes into the picture.
Support & Resistance
And this is the definition of it:
Support – an area with potential buying pressure to push price higher (area of value in an uptrend)
Resistance – an area with potential selling pressure to push price lower (area of value in a downtrend)
Here’s what I mean…
Dynamic Support & Resistance
What you’ve seen earlier is what I call, classical Support & Resistance (horizontal lines)
Alternatively, it can come in the form of moving average. This is known as dynamic Support & Resistance (and I use the 20 & 50 EMA).
This is what I mean…
Not only does support & resistance allows you to trade from an area of value, it improves your risk to reward and winning rate as well.
Watch this training video below and learn how:
Now, another “trick” you can use is to use overbought/oversold indicators.
High probability trading — using Stochastic to identify areas of value
A big mistake most traders make is, going short just because the price is overbought, or oversold.
Because in a strong trending market, the market can be overbought/oversold for a sustained period of time (and if you’re trading without stops, you risk losing your entire account).
Here’s what I mean:
Now you’re wondering:
How do I use Stochastic to identify areas of value?
Here’s the secret…
Are you ready?
In an uptrend, you only look for longs, when the price is oversold.
In a downtrend, you only look for shorts, when the price is overbought.
Here’re some examples:
If you follow this simple rule, you can “predict” when a pullback will usually end.
So, you’ve learned how to identify areas of value on your chart.
…you’ll learn how to better time your entries.
There’re 3 ways you can enter a trade:
- Failure test
A pullback is when price temporarily moves against the underlying trend.
In an uptrend, a pullback would be a move a lower.
Here’s an example:
In a downtrend, a pullback would be a move higher.
According to the work’s of Adam Grimes, trading pullbacks has a statistical edge in the markets as proven here.
You may wonder:
What are the pros and cons of trading pullbacks?
Advantages of trading pullbacks:
- You get a good trade location as you’re buying into an area of value. This gives you a better risk to reward profile.
Disadvantages of trading pullbacks:
- You may potentially miss a move if the price doesn’t come into your identified area.
- You’ll be trading against the underlying momentum.
A breakout is when price moves outside of a defined boundary.
The boundary can be defined using classical support & resistance.
Breakout to the upside:
Breakout to the downside:
What are the pros and cons of trading breakouts?
Advantages of trading breakouts:
- You will always capture the move.
- You are trading with the underlying momentum.
Disadvantages of trading breakouts:
- You get a poor trade location as you’re paying a premium.
- You may encounter a lot of false breakouts.
For a more in-depth explanation, go read The Definitive Guide to Trading Pullbacks and Breakouts.
It works like this…
You’re entering your trade when the price does a false breakout of Support/Resistance. Thus taking advantage of traders who are trapped from trading the breakout.
This entry can be applied in a trending or range market.
Here’re a few examples:
For further explanation, watch this training video below:
Now, the next thing you’re going to learn is…
Place your stops at a point that, if reached, will reasonably indicate that the trade is wrong, not at a point determined by the maximum dollar amount you are willing to lose. – Bruce Kovner
I’m going to share with you 3 ways to do it:
- Volatility stop
- Time stop
- Structure stop
A volatility stop takes into account the volatility of the market.
An indicator that measure volatility is the Average True Range (ATR), which can help set your stop loss.
You need to identify the current ATR value and multiply it by a factor of your choice. 2ATR, 3ATR, 4ATR etc.
In the example above, the ATR is 71 pips.
So if you were to place a stop loss of 2ATR, take 2*71 = 142 pips
Your stop loss is 142 pips from your entry.
- Your stop loss is based on the volatility of the market
- An objective way to define how much “buffer” you need from your entry
- It’s a lagging indicator because it is based on past prices
A time stop determines when you exit your trades based on time.
Instead of exiting your trades based on price, you exit your trades after X amount of time has passed.
You need to define how much time you will allow before exiting it.
You took a short trade at resistance area. But after 5 days it’s not going anywhere, so you exit your trade.
- You reduce losses
- If you have trading records, you can identify optimal amount of time to give your trades
- You may exit prematurely only to see price move in your favor
A structure stop takes into account the structure of the market and set your stop loss accordingly.
Support is an area where price may potentially trade higher from. In other words, it’s a “barrier” that prevents further price decline.
Thus, it makes sense to have your stop loss below Support. Vice versa for Resistance.
Here’s what I mean:
You want to place your stop loss where there is a structure in the market that can act as a “barrier” for you.
Below is a training video that explains this concept in more detail…
- You know exactly when you’re wrong because market structure has broken
- You’re using “barriers” in the market to prevent price from hitting your stops
- You need wider stop loss if the structure of the market is large (this results in smaller position size to keep your risk constant)
If you want to learn more, go read 13 ways to set your stop loss to reduce risk and maximise profits.
Now, let’s move on…
What is confluence and how it impacts your trading
Here’s the thing:
You’re not going to enter a long trade just because Stochastic is oversold, or the market is in an uptrend.
You’d need additional “supporting evidence” to give you the signal, to enter the trade. And this “supporting evidence” is known as, confluence.
Confluence is when two or more factors give the same trading signal. E.g. The market is in an uptrend, and price retraces to an area of support.
Here’re two guidelines for you:
1. Not more than four confluence factors
The more confluence you have, the higher the probability of your trade working out. But…
In the real world, your trading strategy should have anywhere between 2 – 4 confluence factors.
Anything more, chances are you’re going to get very little trading setups. And it’ll take you forever before your edge can play out.
You can take mediocre trading setups, and still make money in the long run.
2. Do not have more than one confluence factor in the same category
If you’re going to use indicators (oscillators) to identify overbought/oversold areas, then use that only.
Don’t add Stochastic, RSI and CCI because it’ll leave you with analysis paralysis. Similarly…
…adding simple, exponential and weighted moving average on your charts, doesn’t make any sense.
If you’re still reading at the point, you’re in for a treat. Because here comes the exciting part…
And here’s my secret (which is what you’ve just learned)…
- Trade with the trend
- Trade at areas of value
- Find an entry
- Set my stop loss
- Plan my exit
If a trade meets these 5 criteria, then its a good trade to me.
Now, let’s learn a new trading strategy, that gives you high probability trading setups.
Are you ready?
Here it goes…
If 200ma is pointing higher and the price is above it, then it’s an uptrend (trading with the trend).
If it’s an uptrend, then wait for the price to pullback to an area of support (trading at an area of value).
If price pullback to an area of support, then wait for failure test entry (my entry trigger).
If there’s failure test entry, then go long on next candle’s open (my entry trigger).
If a trade is entered, then place a stop loss below the low of the candle, and take profit at nearest swing high (my exit and profit target).
Vice versa for a downtrend
**Disclaimer: I will not be responsible for any profit or loss resulting from using this trading strategy. Past performance is not an indication of future performance. Please do your own due diligence before risking your hard earned money.
Here’re a few trading examples:
Here’s the thing:
You may not be comfortable using my trading strategy because it may not suit you.
So, what you need to do is, “tweak” it into something that fits you. And this is what we’ll cover next…
I don’t think traders can follow rules for very long unless they reflect their own trading style. – Ed Seykota
How to develop a high probability trading strategy (a template you can use)
You can “mix and match” different trading techniques I’ve shared with you earlier.
But ultimately, your trading strategy needs to answer these 7 questions:
1. How are you going to define a trend?
You can consider moving average, trendline, structure etc.
2. How are you going to define an area of value?
You can consider dynamic Support & Resistance, weekly highs/lows, Stochastic etc.
3. How are you going to enter your trade?
You can consider pullbacks, breakouts, failure test, moving average crossover etc.
4. How are you going to exit your trade?
There’re many ways to exit a trade. Go read 13 Ways to Set Your Stop Loss to Reduce Risk and Maximise Profits to learn more.
5. How much are you going to risk on each trade?
I would suggest risking no more than 1% of your account on each trade, to avoid the risk of ruin.
6. How are you going to manage your trade?
Will you scale out or scale in your trades? If so, how much?
7. Which markets will you be trading?
Are you focusing on one market or many markets?
If you trade a variety of markets, you want to be aware of the correlation between markets.
So, what’s next?
You’ve just learned how to identify high probability trading setups, and how to develop your own high probability trading strategy.
When you trade it with risk management, discipline, and consistency, you’ll greatly increase the odds of becoming a consistently profitable trader.
Here’s what I want you to do right now…