step-6-identifying-the-low-risk-and-high-probability-setup-regions

Step 6 :- Identifying the low risk and high probability setup regions..

We now have a prediction of how the market is going to behave in the near future. We call this future prediction as Bias. Remember, bias is just a prediction and there is a chance of getting it wrong. So, we must be prepared to protect our account if we are proved wrong by the market. Knowing the high probable direction is not the green signal to enter into the trade.

We must identify the areas on the chart to consider an entry in the high probable direction where the risk is less so that we don’t lose much when the market proves us wrong.

Make a note of the above point. We call the low-risk high probability areas on the chart as Setup / Wholesale areas. Once the setup area is identified, we will wait until the price comes to the identified setup area. Don’t think of the entry yet. One more point to consider. The price must show weakness in approaching the setup area. Then we will place our entry order which we will look into in the future articles.

Now the question is how to identify those wholesale regions?

Let’s get back to our previous discussion about price and markets. We have already understood that the market is not the price chart or the net order flow. The market is a collection of traders making trading decisions. We also know that you can only profit when someone else loses. This has been discussed in detail here.

We now have the high probable future direction from our analysis and we know when someone else loses, there is a chance for you to make money if a trade is taken against them when they accept that they are wrong and are ready to exit their positions.

This is the basic idea behind our strategy. Read the above paragraph again if the concept is not clear as it is very very important. So here it is,

First, we find out the areas on the chart where other traders make trading decisions.
Then, we enter at or before the change of net order flow to that in the direction of our bias.
Now, the next question is, how we will find the traders who are ready to lose on the chart?

You are thinking fantastic if you got the above question in your mind before reading it.. 😀

The simplest way to find the losing traders is to look for those who are fighting the bias or look for those who are trading against our bias and in the direction of weakness.

We already know that the bias that we have formed is a highly probable future direction for the market and generally, moves against this bias are weak and they should be. So, traders who have initiated their trades against this bias are taking a very low probability trade. Once they entered into the trade, if the market is showing weakness in the direction of those traders ( against our bias), they will be stressed out as price is showing weakness towards their targets. When the market finally shows signs that it is not willing to move in the direction of their trades, they will place orders to exit their position. Then we will place our entry orders at or before their exit orders trigger. When their exit orders trigger, it creates a net order flow in the direction of our bias,( ie. in the direction of our trade) that makes our bank account fat. 😀

We always trade against weakness and in the direction of our bias. We reassess our analysis from the first step when the price is showing strength against the bias.

Lance Beggs, in his YTC price action trader book says,

Trading is not about objective analysis.

It‟s about identifying weakness in the market and then having the confidence to get in at a wholesale level fading that weakness.
It‟s about actively managing that trade, in order to maximize opportunity if you‟re proven right and minimize risk if you‟re proven wrong.
Now you know what a setup area is, let’s look at different types of setups we are going to use in our strategy. There are five setups –

PB – Pullback. A simple single-leg pullback within a trend.
CPB – Complex Pullback. A complex pullback is a 3 swing retracement within a trend.
BPB – Breakout Pullback. When price breaks a support/resistance and it holds.
BOF – Breakout Failure. When price breaks a support/ resistance and then reverses.
TST – Test of support or resistance which is expected to hold.
Setup Definitions:-

  1. Pullback (PB) :-

When our rules for future market direction tells us that the current trend will continue ( i.e Rule 1), we will look for a weak pullback against the trend direction. Weakness on the pullback will alert us for a possible PB opportunity.

  1. Complex Pullback (CPB) :-

When our rules for future market direction tells us that the current trend will continue after a complex pullback ( i.e Rule 2 ), we will look for a weaker complex pullback against the trend direction. Weakness after breaking the intermediate pivot in the complex pullback will alert us for a possible CPB opportunity.

  1. Breakout Pullback (BPB) :-

When our rules for the future direction tells us that the support or resistance will be broken (Rule 4 and Rule 6), we watch the price action very closely after the breakout. If the price is accepted in the breakout region and there is a weakness in the pullback to the breakout region, we expect a possible BPB opportunity.

  1. Breakout Failure :-

When our rules for the future direction tells us that the support or resistance will be broken (Rule 4 and Rule 6), we watch the price action very closely after the breakout. If price shows weakness in the direction of the breakout, we expect a possible BOF opportunity.

  1. TEST (TST) :-

When our rules for the future direction tells us that the support or resistance holds the price (Rule 3 and Rule 5), we expect a possible TST opportunity.

These are the 5 setups we are going to use in our trading.

Here are the list of setups that we are going to look for different biases.

Rule 1:- PB

Rule 2:- CPB

Rule 3:- TST

Rule 4:- BPB / BOF

Rule 5:- TST

Rule 6:- BPB / BOF

You must calm down your mind and wait patiently until the market comes into the setup region with weakness. We never chase for entry outside this region as it increases the initial risk. Missed money is always better than lost money.

Once we identify the setup region properly and price enters into it, its time for us to prepare our entries. Before that, we need to learn how to update our bias with the addition of new market information. That will be covered in the next article, Ongoing Market analysis. Step 5 is a simple one. So I will combine it with the ongoing analysis in the next article.

User says:
You have mentioned that you enter in 2 lots and have 2 targets for taking profits. How do you arrive at your targets? Is it the same that you have mentioned in your article “triple-timeframe-analysis-and-construction-of-structural-framework-support-and-resistances”

It would be great if you could write an article someday when you are free where you can take one trading day’s example and what was your rationale behind entering and exiting.

2nd question. Are you a full-time trader? When did you start trading? It would be great for the readers to know a bit of background about yourself and your evolution into a successful trader. An article on this would be great

Reply:
I didn’t say 2 lots. I said 2 units. I divide my full position into two halves. I manage the first one aggressively with a strict target. I give room for the second one to run profits. I have prepared an article about entries and targets and I am going to post it now. Feel free to pose questions if you have any doubts. In fact, it is the last theoretical article about the process and I am going to take some examples from NIFTY to explain the approach.
Yes. I am a full-time trader. My curiosity for trading started in 2011 when I was doing my graduation, but I took it seriously when I got the job. Left the job in 2014 to take trading as my full-time profession. It all happened when I was introduced to the book YTC price action trader book by Lance Beggs.
I will definitely write an article about my evolution sometime in the future. Presently, I am focusing on the methodology that I follow in my day to day trade so that everyone reading this site can understand something about trading.