At this point in the development of your strategy, you have a clearly defined direction in which you are heading. You've decided on the strategy type and market type you are going to trade, and you have a feel for the types of patterns on which you want to capitalize. Now is the time for a brainstorming session in which you should sit down in front of your computer with TradeStation. This is the point at which you start to develop the set of rules that actually make up your trading strategy.

Many traders at one time or another have become frustrated with strategy development. Not because they don’t like it, but because they run out of new ideas to test, or haven’t found anything that works for them.

For example, most traders have tested the Dual Moving Average Crossover Strategy sometime in their trading career. The average trader will look at this strategy and believe that the only thing to test is the length of the two averages. New traders will experiment with many different lengths for the averages. When they don’t find any that work to their satisfaction, they discard the dual moving average strategy concept entirely, and move on to something else. They keep looking for that Holy Grail indicator that they can instantly make into a strategy. We have all been there, and have all discarded many great ideas.

The discarding of an idea, more often than not, is a mistake. I believe that for the most part, any indicator can be made into a profitable strategy. Yes, I said any indicator. When we discard the moving averages, it is usually a mistake because the moving averages by themselves only represent one half of the strategy development puzzle. I refer to this half as the “Set-Up” of a strategy.

The second half of a strategy, the half that most traders ignore completely, is what I call the “Entry.” In this chapter, I will talk about exactly what these two terms mean, and more important, how using them together can turn something as mundane as a moving average crossover into a promising new trading technique.

The Magic of Set-Up and Entry

My experience is that the secret to successful strategy development is to look at a method, or indicator, in an unconventional manner. The trick is to use it in a different and unique way. With Set-Up and Entry, you will look at strategy development in a completely different way. As you’ll soon see, it can provide you with a whole new world of exciting possibilities and ideas to test. It will lift you out of the rut of simply optimizing standard indicators and give you a method of organizing your creativity.

THE SET-UP

The Set-Up is the condition or set of conditions that are necessary prior to considering taking a position in the market. It is the indicator or group of indicators that tell you to get ready to buy or sell. Set-ups don’t get you in the market, they simply make you aware that a trade is in the making.

Examples of set-ups for a trend-following strategy:

• A fast moving average crossing a slow moving average
• The ADX indicator in an up-trend
• Prices moving outside of a price channel
  

Examples of set-ups for a support and resistance strategy:

• The RSI moving into oversold territory (below 20) or into overbought territory (above 80)
• SlowD crossing SlowK when using the Stochastic Indicator
• Prices reaching the upper or lower line of a moving average envelope

Examples of set-ups for a volatility expansion strategy:

• An opening price gap over the high of the previous bar
• The current bar’s range is greater than the average range of the last three bars
• The difference between two moving averages on the current bar is greater than the average difference of the last 10 bars

There are countless other indicators and conditions that could be used as set-ups. In the final analysis, you are limited only by your creativity. There is only one constraint that you should impose upon yourself. It is essential to recognize the type of strategy you are trying to develop and use the different indicators accordingly. You do not want to use a moving average crossover for a support and resistance strategy unless you are using it in a unique way. You would not choose to use the Stochastic Indicator for a trend-following strategy unless you had completely re-configured how it is used.

Most strategy traders do not recognize that these indicators only set up the trade. They are unaware that there are a multitude of ways to actually get in the market once the set-up has occurred. They are not aware that set-ups are only part of the equation and are not particularly profitable in and of themselves.

Beginning strategy developers get discouraged when they try to develop profitable strategies from set-ups only. They quickly run out of ideas to test, because they use up all their ideas as set-ups without trying to combine them with various complementary entries.

By trading only set-ups, you lose the added precision, accuracy and increased profitability of a strategy that uses both set-up and entry. If trading set-ups by themselves worked, and was profitable, trading would be easy and all traders would be rich.