Uncertainty and Trading Success: The Discretionary Ruled-Based Plan 3

We are in the final stage of the series.

I left off The Discretionary Ruled-Based Plan 2 considering the setups for a responsive trader. Let’s continue today with the setup for a breakout trader.

The win rate for breakout trades is around 30%.  To improve the rate, I took an idea from Bob Volman’s “Understanding Price Action“: the False, True, Pretend (FTP) setup.  Bob uses 5-minutes charts. I found the FTP could be just as useful in any timeframe.

Essentially, the FTP is a 1-period swing sideways congestion pattern. For me on the subject see:  “FTP: A Breakout Filter“.

So you know your setup, what’s next.

I usually like to enter on a lower timeframe bar showing that the correction is over or that a breakout is genuine. In both cases, I am looking for what I call an acceptance bar. The most common examples are:

• A bullish acceptance-bar has an open no higher than the bottom 25% of the range and a close no lower than in the 25% of the range.
• A bearish acceptance-bar has an open no lower than the top 25% of the range and a close no higher than the bottom 25% of the range.
• In both cases, we see normal range and normal volume for the trigger bar.

There are variations, What you are looking for is evidence that either:

1. (for the responsive trader) the correction is over, and the dominant trend has resumed; or
2. (for the breakout trader) the breakout is genuine and will continue.

Some setups have their triggers. For example, I have a Linear Regression Band setup which has its own entry bar. (See Linear Regression Bands I and Linear Regression Bands II).

The next step is to ensure we have an adequate estimated reward: risk (R: R) for the trade. For this step you need to know:

1. Your positive expectancy ([average dollar win x win rate] – [average dollar loss x loss rate])
2. Your initial stop location and
3. (For me) My core profit target. To calculate the target, I need to know the average price for my first and second thirds exit prices. (I use the Rule of Three for most trades). Once I have worked out the possible profit, I can work out, given my stop loss, whether the reward: risk makes the trade worthwhile. Just input the profit and risk numbers into the expectancy formula. The product must be one that your stats say will lead to long-term profitability.

So that’s it. You have all the elements for a discretionary rule-based Method. Only more step and that’s to execute the plan.

This step is a 2-step manoeuvre:

1. The stalking phase: here patience is the key; you must be prepared to let the trade come to your zone and demonstrate the desired setup.
2. The action phase: now you wait for your trigger, and when you see it, you act unhesitatingly.

• You enter with the calculated position size
• You place your hard stop
• You know what the market has to do for you to exit the trade (what I call my soft stop).

In the action phase, you need only execute. All the preparation work has been done. Too often novice traders fail to execute their plan, and then they take an impulsive (thoughtless) trade.

What do you do? What’s your plan?