An edge is simply a measure of probability. Your edge depends on you trading in the right emotional standpoint while always adhering to your rules. See the chart below for reference:
Your 'edge' in technical analysis is the trade setup. But every bull flag is not made equal.
So -- How can we measure it?
What will separate you from the pack is the layers of probability surrounding the trade. The Layers of Probability (LOP) relate to how many factors you have working for you in your trade.
You need to be certain in the viability of your edge because confidence (& mental capital) are the most important attributes a trader can possess. (Ok fine, patience too.)
How can we combine these layers of probability to benefit us? Let's look
at a few A+ setups from over the years and the LOP they provided:
AAPL through $120 was an A+ trade that we absolutely crushed. We had complete conviction in the trade.
Let’s talk about the LOP in this AAPL trade that gave us the conviction to pound the table & subsequently went straight up for 10 points.
Apple, the world’s most relevant company, is setting up for a break of all time highs.
The bull flag came about after an earnings beat, surprising the street with a 17% higher EPS.
The stock gapped up to a huge level and went sideways for 1-2 weeks.
The market was stabilizing after a choppy period, breaking higher.
- It allowed the 8 SMA, the momentum moving average indicator, to catch up and get very tight on the daily.
- Showed all the classic symptoms of a great bull flag breakout.
- Heavy volume on the move up (creating the flagpole).
Followed by a rest period characterized by low volume and sideways action (creating the flag).
- Eventually followed by a breakout on heavy volume definitely breaking through resistance making it’s next leg up.
Here is the original send out from the 3/25/17 Newsletter:
We achieved about 20:1 risk/reward when it was all said and done. Let’s talk about the LOP:
Tesla was coming out of an insane uptrend -- it broke a longer term downtrend and ran over 100 points from 180 to 287 in just over two months. The uptrend is strong, those buyers aren’t going anywhere. I wasn’t going to chase so I waited for a setup -- as you can see by the wedge mapped out above.
Tesla has a notorious short float (~30% at the time), which is why it trades with such great momentum. Short covering creates momentum because to take a loss, they have to buy the stock, creating upward pressure. That, paired with the traders going long at the same time means you will have yourself some momentum.
- The TSLA monthly chart had been on my radar for some time. It had virtually been in a 3 year bull flag on the monthly chart (pictured below). The blue arrow is $261, where the wedge noted above triggered. We LOVE it when trades triggering on the daily coincide with weekly & monthly levels.
Remember how I said I missed the huge 100 point run so I wanted to wait until I saw a setup? The biggest clue of a setup was the inside week (pictured below). I love it when a stock has an inside week just underneath a level. An inside week is a symbol of consolidation -- buyers meeting sellers. So I knew this was the entry I was looking for because I needed a confirmation of contraction (tightness) so I had a calculated place to enter where I could expect expansion (breakout).
OLED through $60 IMMENSELY exceeded expectations running over $25 higher in 6 weeks. Let’s look over the cues:
Here is the original send out from the morning OLED triggered:
OLED created virtually a PERFECT wedge pattern
- Moving averages consolidating together indicating an expansion may occur soon
- Volume began increasing towards the end of the wedge
Cataclysmic volume to break out of the wedge as well as the immediate days following
- The Sector has been piping hot
Recognized the strength in chip stocks (SWKS, QRVO, AVGO, CRUS) over the past few sessions which put them on our radar
- The chart COULDN’T have gotten any TIGHTER
- You have to know the names you’re trading and what to expect their daily trading ranges to be
- For example I’m going to expect much more out of a stock like TSLA than I will one like BAC
- OLED is a name that generally moves $5-8 a day so when it began trading in $1-2 ranges I knew it was time for this wedge to break soon
Things can’t stay tight forever
So in summary, let's look at the common characteristics of these trades. They had a well defined chart pattern with clear indications of the Layers of Probability surrounding the trade. There was some fundamental, short term news that would definitely affect how it traded over the next few weeks. In Apple it was coming off positive earnings. OLED the entire sector was piping hot. TSLA subsequently dropped news their demand was at record highs the day after we initiated the trade. You tend to get lucky in the strong names from the news front.
So in the simplest sense the formula is A+ Chart + Positive News Catalyst.
Stacking LOP will give you the conviction you need to truly crush trades. You will get to a point where you usually risk 1k per trade but this one, for example you want to risk 5k (or whatever is relevant to your trading) because you know it could be a special one.
Do you have balls?
Your task is to find a macro bullish pattern similar to the examples uses above that is currently setting up. Not some name that has been flagging for 2 days, a chart that has been setting up for 6 months plus. Let's see the chart pattern draw out, the complete game plan and the layers of probability mentioned as they were in the examples above.
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