Back in November I introduced a “pro trader’s checklist” that included the components required to create strategies. To define momentum, or who controls direction, we need to establish where fair value lies. Once we determine value, we can define risk. When risk is identified, timing entry is next on the agenda, followed by projecting and protecting profit.

Timing entry depends on a few factors. First, is the type of trade you are looking to execute: a directional or vertical trade versus a contrarian or horizontal trade. Breakout or vertical trades are most common after a market has established a symmetrical fair value area with below average ranges and volume over several days. The contrarian trade is best when a market is thought to be overbought or oversold.

Playing for the trend or breakout type trade requires a tool or indicator that reveals when a market has consolidated for too long or has spent too much time at price. For short-term breakout signals I search for markets that have been consolidating for five to eight days with decreasing volume and range length. This pattern is illustrated twice in the SLV chart below.

For the contrarian trade, when selling volatility is a better strategy, search for markets that have moved too far, too fast. There are indicators (MACD, Stochastics, RSIs) that reveal overbought and oversold situations. The formula I prefer is to search for markets that have risen or declined the length of an average month range in less than a week. Another indication of a move that is too far, too fast is when a market moves the length of an average week in less than 48 hours.

Choosing the type of trade is often dependent on a five- to eight-day setup. Directional or long premium trades are optimal after a week or so of tight ranges and low volume, while short credit spreads are best when the speed of a move has exceeded the normal pace.  

John Seguin, Market Mentor Mentoring