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BILATERAL TRADE SETUPS

When it comes to trade setups, it's not always an either-or situation. In fact, you can double your fun with bilateral trade setups.

Start by overcoming directional bias when you look at a price pattern. Although you may see it in your mind as a long or a short, chances are it will work in either direction. The trick is to let the price action tell you which way to go.

Let's back up a step and see how this works. Many patterns exhibit well-defined support and resistance. Bilateral setups use both levels for trade execution. A long entry is signaled if price breaks resistance to the upside. Conversely, a short sale is signaled if price breaks support to the downside. But you still have more work to do before taking a bilateral trade. After all, making money is the whole point of the exercise.






Every trade setup generates a unique reward/risk profile. In other words, it tells you how much you stand to win or lose should you decide to take a position. Each side of a bilateral setup carries a different reward/risk ratio. Most of the time, one side shows more profit potential than the other side. This can be frustrating because the calculation is independent of the odds that either outcome will actually take place. So you may have a great, high-odds setup with little or no reward, or a lousy, low-odds setup that would earn a fortune if it ever happens.





The price trigger complicates bilateral trade entry. Trading signals come in all varieties. The best ones ring very loud bells within very narrow price levels. One classic example is a high-volume breakout through a major moving average. Bilateral strategies force you to locate trigger prices on both sides of the pattern. Many times one side will bark much louder than the other when price hits the associated trigger.





Bilateral setups work best when they fit into larger cycles that encourage price movement in either direction. For example, a stock drops off a broad rally into an extended correction. Smaller patterns within this correction may trigger short-term rallies or selloffs. Bilateral strategy lets the trader take advantage of the mixed environment and execute price swings in both directions.

Let's review the signposts of this two-way trading street. We need well-defined support-resistance levels, a defined reward/risk ratio on both sides of the equation, clean price triggers and a big picture that lets us execute in either direction. Sounds simple enough, and it is.

The difficulty lies in our ability to control bias and to let the market tell us which way to go. Very often the best trade is in the opposite direction from the most obvious outcome for that pattern. In other words, the majority piles in one way, but the profit comes from trading it the other way.





The good news about these fascinating patterns is they may tell you when the move is about to happen. Congestion often narrows toward a trigger point. We see this in triangle patterns where two trendlines converge in price and time. Bilateral setups may show this convergence through simple lines, or sometimes through more complicated volatility cycles.

Volatility drops off through the formation of most bilateral patterns. It tends to reach a definable low, and then trigger a sharp price expansion. Traders examine narrow range price bars near support or resistance levels in order to predict impending price triggers. They also study classic volatility indicators to locate these turning points in developing patterns.

Swing traders go long or short, depending on the opportunity. Bilateral setups cut their workloads by presenting two possible trades in a single pattern. So always look at both sides of the equation when examining a price chart. Then leave your bias at the door, and take whatever the market gives you.

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SCANNING TIPS AND TECHNIQUES

We spend too much time looking for stocks to trade. Surprisingly, stock picking is one of the easiest skills a new trader can learn (while actually taking a position is one of the hardest).

The trick to finding good setups is scanning dozens of charts in seconds, instead of hours. And this isn't as hard as it looks.

First, let's talk about stock scanning. Chart database programs (such as Worden's TC2000) feature advanced market scanning tools. With them, you can write Boolean statements that will search quickly for your needle in the market haystack.

Many folks think the purpose of scanning is to find perfect trades that can be mindlessly executed. Nothing could be further from the truth. The best scans just take you to the next step, where you discover the opportunity for yourself.

Your two eyes are better tools for locating good trades than the most carefully written market scans. The most effective formula will uncover a lot of useless garbage but also let you find the real gems. So keep your search sloppy, and don't try to optimize. Instead, put your resources into a fast computer that lets you flip through your output at the speed of light.

Let's examine five visual aids to speed up your stock scanning. Train your eyes to look at charts in this way the next time you sit down to do your market homework.







You don't want to ski on the Bunny Slopes. There's little profit for traders when price rises or falls in a very gentle pattern. Real opportunity comes when strong tension between conflicting forces gets released in a big move. Bunny slopes never build that tension and should be avoided if you're looking for short-term gains. The good news is it takes only a second to see this flaw on a price chart.





Border Disputes happen between price bars and intermediate moving averages. These conflict levels define important setups because so many players react to these zones. Keep your eye on the interplay between price, the 50-day and 200-day moving averages as you flip through your charts. No single pattern defines these disputes, so stop and investigate when you see something interesting.





Davy and Goliath traps many traders. This trend-relativity error happens when you see a great pattern, but miss the support or resistance that's going to screw it up. Avoiding this error is simple. Look above and below the breakout price for the setup that's catching your eye. Then do the math. How far will it travel before it runs into the mean ogre?





Trend Mirrors tell you to look to your left before taking a trade. Mirrors show all the past stuff that's going to affect price movement right now. One of the great trading secrets is that price reacts a lot more than it acts. In other words, old debris in the charting landscape generates most price swings. So look for all the past highs/lows, gaps, volume spikes and candle shadows when you see an interesting setup in the present.






If you have to look, it isn't there. The Bad Hair Day refers to a price chart that makes absolutely no sense when you first look at it. So what do you do when an oddball pattern catches your eye? You waste more time and try to figure it out. When a chart doesn't slap you across the face at first glance, move on and find one that does.

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THE PROFITABLE TRADER

Let's look at the differences between profitable and unprofitable traders. Is it a question of experience, or are some folks just born with the talent to play the markets successfully? How does risk tie in with profitability? Are profitable traders more willing to make riskier trades?

Author Mark Douglas talks about three stages in becoming a profitable trader. First you learn how to find promising trade setups. Second, you learn how to enter and exit those positions at the right time. Third, get to a point where you build equity on a consistent basis. The secret to this third step is really no secret at all. You master the discipline required to follow your methodology, plan or system.

Traders need to make an important choice early in their careers. They can decide to follow a specific method that forces them out of the market during unfavorable conditions. Or they can master a broad range of skills, and then apply the right one at the right time. Neither approach is right or wrong, but both require paying close attention to the profit-and-loss feedback.

Most unprofitable traders rely on a poorly matched execution style, or a good one they haven't mastered yet. Very often they fail to recognize critical errors in their methodology because it was learned in a book, or through inappropriate conditioning, i.e., making money on bad decisions. Realize that profitable traders know all the weak points in their strategies and exercise damage control at all times.

You can't understand your methodology until you analyze your profits and losses. Identify its weaknesses quickly, and then decide if it really works at all. You may discover that your whole approach to the market isn't right for your lifestyle, emotional nature or long-term goals. For example, you could be a scalper with the disposition of an investor, or a daytrader who hates risk. Bad things will happen when your system doesn't match your personality.

Traders hate to think about discipline. After all, it's not as sexy as just becoming a market gunslinger. But the bottom line is that most of us don't follow our own rules. This is ironic, because the folks who ignore the reasons they lose money are the same ones who spend thousands of dollars attending trading seminars. Personal discipline is the one thing you can't learn sitting in an audience.

Discipline and money management go a long way toward becoming a profitable trader. But let's be realistic. However you trade, you must be confident in the positive expectancy of your style or methodology. This poorly understood concept refers to how much profit you can reasonably expect to make vs. each dollar risked on a trade. Gamblers know this equation as the player's edge in a casino. The problem is that most of us don't understand our strategy well enough to determine whether or not it has a positive expectancy.

System traders use backtesting to gauge the positive expectancy of their systems. Retail traders choose entry and exit without this methodology, so they need to compensate through extensive record-keeping and analysis of each trade result. Even so, they could be fooling themselves into believing they have an edge in their pursuit of profitability.

The sell side of the positive expectancy equation is more important than where you buy. Research suggests that a very profitable system can be built using random trade entry. Yes, you heard that right. It's possible to make money in the same way as a chimp who throws darts at a dartboard. But the hairy primate still has the same problem as the losing trader: He doesn't know when to take money off the table.

Positive expectancy requires a robust exit strategy. But you already knew that, didn't you? Volumes have been written about money management techniques, such as cutting your losses, riding your winners and trading adequate reward/risk. But somehow, losing traders continue to outnumber profitable ones by a very wide margin.

One aspect of positive expectancy is more difficult to manage than any pure numbers game. All trading styles experience drawdowns, and profitable ones are no exception. Traders routinely abandon profitable methods because they hate to lose money. They stop following perfectly good rules because they aren't getting the instant gratification they want from the markets.

If this all sounds like a big loop from the top of our discussion, it's meant to be that way. Losing traders get stuck in a vicious cycle. They want to profit from the market so they come up with a strategy to make money. They trade the strategy until it frustrates them to the point they abandon it and go looking for another strategy. In the process, they never take the time to find out whether or not it had positive expectancy in the first place. In other words, they don't let their methodology mature enough to watch its real potency bear fruit.

Which brings us back to discipline. Sure, it's boring to plan the trade and trade the plan. But it's the only way to break this losing cycle and get on the road to consistent profitability.