From the May 2013 issue of Futures Magazine • Subscribe!

Beating uncertainty by scaling into trends

Look at the volume of any bar on a chart. You will notice that it is about the same on bars that, with hindsight, are obvious buy or sell signals. Casual observers might ask how that can be. Doesn’t everyone enter on these clear-cut setups? The reason volume stays consistent is that while individual traders watch for these traditional setups so they can use tight stops, institutions see setups every second of the day.

A chart is a representation of what is taking place in a market — where buyers and sellers come together to determine a fair price at which to buy or sell. Of course,  buyers want to buy lower and sellers want to sell  higher, but what constitutes high and low is not that clear.

As a result of this uncertainty, traders rarely are more than 60% sure of whether the next several ticks will be up or down. Probability is only high during strong breakouts, but these are rare. Usually, confusion reigns; as a trader, you have to learn to trade when you are not quite as confident as you would like to be.

New traders often think of a setup as a reversal bar or pattern. A broader definition of a setup is any reason to take a trade, and it is composed of context as well as a specific signal bar.

Context is simply all of the bars to the left of the bar in question. For example, when you are looking to buy, you want the market to be testing a support level, such as a prior low, a trendline, a measured move projection, a breakout point or a moving average. You then hope to see a signal setup such as a bull reversal bar. This indicates that the market is reversing up from that support, and it increases your confidence that buying above the high of that bar will result in a profitable trade.

That said, if you wait for these perfect setups, you will not take many trades. Also, you will miss many of them because of complacency and you’ll be unable to act when the setup forms. For example, there are 81 bars on the five-minute chart of an E-mini day session. If you are watching every tick for several hours and your setup has not formed, you naturally will begin to believe that it won’t form any time soon.

This mindset will make you unprepared to trade. Great setups usually happen quickly and unexpectedly, and rarely are clear until many bars later. Beginners invariably miss them because they always are searching for certainty.

Such an attitude demonstrates a misunderstanding of how markets work. There has to be someone taking the opposite side of your trade, and if your trade is such an obvious buy setup, there will not be anyone willing to sell to you. Even the best trades are less certain than you would like them to be. At the end of the day when you print out a chart, the setup is clear, but that is because you now can see all of the bars to the right. In real time, you only see the bars to the left of your setup and signals are far less certain.

One way to handle this uncertainty is to scale into trades.

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