They Are Not As Important As You Think

I noticed at the beginning of my career as a trading coach that when people talked about a trading system, what they were really taking about is what I would today call the setup to a system. Yet, setups are a very small part of what is necessary for a complete trading system. And interestingly enough, today people still claim their setup conditions as their systems.

Let's look at an example, one of the most famous systems around: William O'Neil's CANSLIM system. What is CANSLIM? It's a set of abbreviations for O'Neil's setups. And when people talk about CANSLIM, they mostly hear about what each of those letters stand for in some detail. However, the CANSLIM setups, in my opinion, are the least important aspect of what makes that system successful or unsuccessful.

In Chapter 8 of the second edition of Trade Your Way to Financial Freedom, I identify many different types of setups that show the breadth of this topic. And, of course, it is so comprehensive because most people used to think it was the key to trading success.

The following is a brief discussion of ten of the setups that I consider extensively in that chapter.

1) Failed Test setups occur when the market wants to test some area. For example, the Turtles used to trade 20-day breakouts, so a 20-day high is considered a test area and a failure of that to continue is what might be called a failed test setup.

2) Climax Reversal setups are another type of setup. Here the price goes parabolic to a new high and then fails. These are often the start of big moves in the opposite direction.

3) Retracement setups are often used by trend-followers. Here the market is identified as being in a clear trend (the first part of the setup) and then it reverses (the second part of the setup) and then the trend continues.

4) Time setups might occur when you think that some move is due at a particular time period as a result of some “mysterious order to the universe” concept. If you have one of these, then the time at which the setup is about to occur might be considered the setup.

5) Price data in sequence is another form of setup. I've already given one example of this in the retracement setup, but there are many different kinds.

6) Fundamental data are often used as a setup. For example, an analyst might conclude that there is a pent up demand for some commodity. Demand usually means to potential to rise in price so the decision that demand is rising might be considered a setup.

7) Volume data might also be considered a setup. For example, the Arms Index, which involves volume data, might be considered a setup.

8) Component data might be used as a setup. What does that mean? Well, if you are trading an index such as the S&P 500, you could find important information suggesting a move by looking at what some of the individual stocks are doing. But that's just one example of component data and there are many.

9) Volatility is often considered a setup. For example, when volatility contracts extensively, it's often comparable to a spring waiting to uncoil and thus could be considered a setup.

10) Business Fundamentals might be considered a setup. For example, value investors have different ways to determine when a stock is undervalued and that usually is a setup for them to buy. Warren Buffet has a number of business fundamentals that he reviews about each stock before he buys. And these are all examples of what might be called business fundamental setups.

Dr. Van K Tharp
TradingEducation.com

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