Trading Setup – The first block of a trading system
What is a trading setup? A setup in a Trading system can be simply explained as laying the trap for a trade to fall in. Like a hunter lays traps for its prey, while trading we have setups. For people who beleive in astrology can consider is as an alignment of favourable stars.
Setups are not an indication that something will happen. They are an indication that something may happen. Its after a setup is complete the trader starts looking for entry points. Discretionary traders go with their gut feel while Mechanical Traders go with another rule called Entry after the setup.
An example of setup can be again 13 EMA crossing over 50 EMA. This is a simple setup. If 13 EMA goes above we can consider it a long setup and if it goes below we can consider it a short setup. Setups though need not be indicator based, they can be price action based like a hammer candle could be a setup, or a 52 week high (year) breakout can also be a setup.
Now if we consider the above as points of entry instead of being a setup, a trader would keep going long and short alternatively and have a lot of whipsaws. A setup before entry makes a system more concrete.
Trading Setup: The types
Its up to a trader about how many types of setups they want to have. I personally like to have and actually have a system which has 3 setups.
- The long setup
- The short setup
- The neutral setup
The system of 13 EMA and 50 EMA defined above in example has only 2 setups. The long setup and short setup.
To consider all 3 forms of setups lets consider another example, we use the 13 and 50 EMA but add another timeframe to it. So we get into a 2 timeframe system, lets say one timeframe is hourly charts and the other is 15 minutes charts.
The long setup:
In above system an example of long setup could be when 13 EMA is above 50 EMA in both the time frames. Long setup means that the trade has entered a scenario where we would like to go long.
The short setup:
Short setup would be say when 13 EMA is below 50 EMA in both time frames. Short setup implies that the stock, future or commodity is now in a place from where we would like to go short.
The neutral setup:
Similarly a neutral setup could be when the 13 EMA is above 50 in hourly charts but below in 15 mins chart or vice versa. That means when trends in both charts is not in sync. This would basically imply that the stock or future is now is a no trade zone and we just sit back and wait for a long or short setup to form.
This is a just a framework example and can differ from person to person. A trading system is created by a trader, and can have any rules that the trader wants. Nothing is set in stone.