Setups: Criteria

In another freebie article, Dan "The Man" Fitzpatrick describes the 3 elements of a successful trading plan. From my opinion, it is more of a checklist of criteria for what stocks to trade. It is not only good to review that, but at the same time, now is as good a time as any to record a documented trading plan.

1. Profit potential. This is not the same as profit target. Many traders define their profit targets in terms of R. So a risk-reward ratio of 3:1 would be equivalent to 3R, or 3 x the amount at risk. However, Dan says to also look at profit potential, which looks at the potential for a stock to move up to the next resistance level. This is pretty significant, because you can manipulate your R's to always get a 3R profit target, but there's less subjectivity about a stock's resistance level.
So, not only should a potential of a 3xR profit be considered, but also the potential of hitting the next resistance level should be considered.

2. Always Set your stop just below the nearest established support level. Never move this stop loss point unless the stock breaks above the nearest established resistance level. Never add to this position unless the stock breaks above the nearest established resistance level.

3. Consider the stock's sector and industry group. Oil stocks will move in the same direction as $XOI, gold stocks will move in the same direction as GDX, semi stocks will move in the same direction as $SOX. It is alway better and less risk to select stocks that are moving with its sector. If you find a stock that is moving in opposite direction to the sector, make sure you have a good understand why you want to make the trade.

4. If you can't find any stocks that meet the above criteria, then there is no trade to be made.