Swing to Win With These 3 Trade Set-ups!

James DiGeorgia

Want better trading results? I’m here to help! Today we’ll look at another key concept: "set-ups."

I’ll start with a quick review. Last Thursday we looked at the simple concept of bias. Either you want to buy/hold stocks, or you want to sell/short stocks.

Traders and investors run into problems when they "fight the bias." While it’s possible to succeed if you own stocks when the bias is negative, or short stocks when the bias is positive, those scenarios tend to result in low-probability trades.

Bias depends on your time horizon. A day trader might look at 10-minute charts to judge bias, while a long-term investor prefers weekly or monthly charts. My friend Phil Erlanger popularized bias over the years through his writings, videos and Erlanger Chart Room software.

In last week’s bias discussion, we look at weekly and monthly bias for SPDR Gold Trust (GLD) with the Erlanger Displaced Moving Average. As of last night, the GLD weekly bias was still positive despite a pullback on GLD. The monthly GLD bias is still negative.

Now that you understand bias, you’re ready to look at set-ups.

A great set-up indicator is like a pitch to the batter right in the middle of the plate. All the batter has to do is swing correctly, and it will be a home run. In the big leagues, they call it a "fat pitch."

Here are three different set-ups I like …

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Set-up #1: Short Ratio

Sentiment indicators like short interest can be great set-ups. When too many people hold short positions in a stock, there is high potential a "short squeeze" will push the price higher. The opposite is also true: Unusually low short interest means excessively bullish sentiment and a possible "long squeeze."

The short ratio is simply the number of shares sold short divided by the stock’s 12-month average share volume. For GLD, the short ratio is currently 2.68.

Next, we look at the range of the short ratio over the past 5 years on a weighted basis. Erlanger calls this the "Short Intensity." GLD has a current short intensity of 93%. This means that the shorts are making a big bet on a historical basis.

Now let’s combine bias with the short ratio and short intensity. I see two things in GLD right now:

  • Bias is positive on a weekly basis, and
  • Short-selling is high, which creates the potential for a short squeeze.

This is a good setup if you own GLD — and a bad setup if you are short.

Set-up #2: Option Selling

Option selling is another great setup. When put activity is too high and the stock has sold off, you have a potential "put squeeze." When a stock has had a big run and call action is too high, it sets the potential for a "call squeeze."

You can see whether put or call action is excessive with the Erlanger Option Rank. This indicator tracks open interest, premiums, money flow and volume.

Currently, GLD is coming off a "call squeeze" so this pullback isn’t surprising.

Set-up #3: Seasonality

Seasonal patterns can be great set-ups for stocks or ETFs. Certain names tend to do better or worse depending where they are on the calendar. Phil Erlanger created a seasonality confidence score he calls the "Cycle r."

For Cycle r, a rank of 1 means perfect correlation, zero is no correlation and -1 shows an inverse correlation. The current Cycle r on GLD is 0.64, a positive correlation.

Adding in what we saw before, GLD is setting up for a short squeeze into seasonal strength. Potentially, this combination of two set-ups means GLD short-sellers face a clear and present danger.

This is how set-ups work. A good set-up is more than just anecdotal observation. Hard data is much better than casting your hand into the wind. Set-ups help you see opportunities and be on the correct side.

Over time, a "technical trader" will outdistance an "opinionated trader" who lacks a system. Without indicators like bias and set-ups, it is easy to be stuck in bad trades.

Next week we will tackle how to "trigger" your buy and sell moves.

Cheers and Hit ’Em Straight,

Geoff

P.S. My colleague James DiGeorgia and I just showed a small group of traders how to grab potential gains of 16.9% … 20.3% … 24.3% … 28.7% … and 50.7% … just in the space of a few weeks! How did we do it? Find out here.