High Probability Trading Setups

High probability trading setups and strategies are something that most traders aim for.  Who doesn’t want the odds in their favor when risking their capital?

Of course the setup is just one component of having a higher probability of a winning trade, but it seems to be the most searched for variable with people looking to book profits.

This post is designed to shave years off your learning by giving you the setups that have worked for me and others over the years.

I will say that over thousands of trades, the ones that have given the edge are ones that follow the direction of the trend.

 

How To Determine If The Market Is In A Trend

Since the highest probability trades, in my opinion, are in the trend direction, it’s a good place to start.

Of course, once a trend is underway, they are pretty easy to spot. But having a method to determine trend before it’s running into exhaustion is important to your success.

There are two simple methods to determine the trend:

  • Using a moving average and price relation to it
  • Watching price action

I say simple because you can know, at a glance, if your market is trending and in what direction.

Moving Average Trend

I’m going to use the 30 period moving average.  It’s not too short that will have you whipsawed often and not too long that the trend change is near the end of the move.

Here are three simple rules you can follow once you have applied the moving average indicator to your chart:

  1. Determine the slope direction of the moving average
  2. If long, look for two higher lows above the average (two lower highs below the average if short)
  3. Trend is confirmed when the highest high or lowest low (shorts) is broken

Let’s take a look at this stock chart of Paychex:

paychex moving average trend

On the lower left, while price has broken the moving average, it doesn’t have to highs below the average.  We would still be in an uptrend at this point.

We then get 2 higher lows above totally above the average.  Once price breaks the highest of the two candles, the uptrend is reconfirmed.

In the middle of the chart, the highs are touching the average.  We then get two highs completely below the line.  Once price breaks the low of the small red candle (with the arrow), the downtrend is confirmed.

Finally on the right, two lows plot above the average however price at that point had not breached the highest of the two candles.  You’d still be considering shorting as the downtrend is in force.

Price Action Trend

Price in an uptrend must make a series of higher highs and higher lows while the downtrend is the opposite.  The key to this technique is seeing price acceptance during the trend change so you don’t get pulled into fake outs.

You also want to determine what a swing point is.  For this example, we will use a five candlestick pattern.

Looking at this intra-day chart of crude oil futures, you can see where you’d be looking to short as well as when to look for longs.

price action trend

Once you’ve determined the trend direction, you would then look for setups that trigger in the direction of the main trend.

 

Setup #1 – Range Pre-Breakout

Once price stops putting in higher highs but has yet to put in a lower low, we’ve gone from a market in an uptrend to a ranging market.

Since we are trading with the trend, we need to see some signs of where the breakout may happen.

This chart of IMB is in a trading range on the daily chart while the overall trend direction is up.  We want to get long and are using the 60 minute chart to zero in on price action.

range breakout

What you are seeing is price basing just under resistance.  Traders that position inside the base are in a position before the breakout.  I have found that these will often lead to fast gains as breakout traders pile into the move.

If that breakout does being to fail, you’ve room to place a stop that looks in some portion of the gain.

Key point:  Use a time frame that is lower than your setup chart so you are able to see the base when it forms.

 

Setup #2 – Trading Reversals Off Pullbacks/Rallies (Flags)

Market ebb and flow as they build the trending structure.  When trading the reversals off of pullbacks in an uptrend, we are essentially seeing the higher high put in, the market pulls back to put in a higher low, and we trade the reversal back into the trend direction.

I like to use a variation of standard trendlines on pullbacks and that is to draw through the candles from the high to the low.

trend lines

The red line is drawn from the highest point to the lowest point.  The line is then copied to the outside of the candles.  I find this method takes into account how aggressive the pullback is.  Just personal preference.

This is a chart of Litecoin and according to our moving average trend rules, buying is the higher probability trade.

high probability setups pullbacks

Price pulls back and we draw the trend lines as discussed.  The green arrows are marking the zone where a trader would buy.

Key point:  Consider using a momentum indicator and only take reversal entries when the indicator is showing either slopes upwards or higher highs.  This gives a greater chance that the market will have some movement upwards.

 

Setup #3 – Failure Tests of High/Lows

This is a price action play that takes into account price probing higher/lower areas, traders entering positions, and quickly putting their trades under water.  By doing so, you can ride the wave of price movement when they have to close out their positions.

You can also use this as a counter trend play but in this example, pure trend plays are what we are looking for.

failure tests

Our moving average trend rule has traders on the buy side as price never breaks the lowest low of the two candles.  When price breaks the low, we now have a lower low and traders pile in to the downside.

The lower shadow shows buyers stepped in and traders that were short, find themselves in a tough trade.

We have two options to take advantage of their exits (which we know they have to):

  1. Play the break of the reversal candle
  2. Play the break of the high of the inside candle

Either one puts you in profit before we get the big down candle.  A break of that inside candle to the upside gives you another reversal long play.

Key point: These patterns occur all over the chart so be sure it takes place near an obvious swing point on the chart.

 

 Setup #4 – Triangle Breaks

A triangle is just a fancy name for an inside bar but includes the previous bar as well.  These are times of indecision where buyers could not take out the high of the previous candle and sellers failed to break the low.

But one side has to win.

My money is on the trend side.

Here is the stock chart OKE on the 15 minute time frame.  We are using the trend direction of the hourly chart which is up.

triangles

We need four points for the triangle and once we have those, we can start to use our trend line drawing rules to find a trigger before price breaks out.

Going back to setup #3, if you see a failure test of lows, you could also use that for a trade entry trigger.

Key point:  Day traders tend to like this setup as you can position easier on the lower time frame than you can on the daily chart as an example.

 

Conclusion

These setups are just the start of a high probability trading strategy.  Traders still must determine their style of risk management and profit target techniques before using these.  Once you run out of money in your account, it can be a struggle to ever load it up again.

Successful trading needs a trading plan is vital whether you are a day trader, swing trader, and/or investor.  While these setups stand a greater chance of success, the realities of trading is you will lose.  You will lose in streaks.  Profitable traders treat trading like a business and have a plan of everything they will do for setups, entries, exits, and risk.  Make sure you do as well.

× Comments are closed.