There’s a lot to be said for consistently keeping and maintaining watch lists. Maintaining watch lists will not only keep you prepared for when the market turns in your favor, it will also provide you with valuable insights into the overall health of the market.
Today you will learn how to create Top 10 Setups in Bases and Ready Lists, why the are so useful, and some of the novel insights these lists provide into the overall health of the market.
Creating these lists boils down into 3 basic steps. They include:
- Finding Stocks that are Setting up in Quality Base Patterns
- Rating Setups
- Ranking Setups
It’s important to note that you should start by looking for stocks that are in your Universe only. If a stock didn’t make it into your Universe, you shouldn’t be interested in it. Stocks in the Universe have already passed our scans and are the ones we want to focus on. Narrowing down the playing field saves us time and ultimately helps increase our chances for success.
Step 1: Finding Stocks that are Setting up in Quality Base Patterns
During our initial search for stocks setting up, we only look at the weekly charts. Even though we will later pinpoint our pivots, advanced pivots, and various support levels on daily charts, finding the setups on weekly charts places the longer term time frame in our favor. It also cuts our workload in half by not duplicating effort later on.
Every setup we find is immediately placed onto a “Ready List” for further evaluation. At this point, we’re only interested in quickly compiling a list of potential candidates for the week ahead. Going through the Universe List (typically between 150-200 stocks) shouldn’t take more than a few minutes to do after you get the hang of it.
The bullish setups we look for include:
- Cup shaped base
- Cup with handle
- Flat base
- Double bottom
- Ascending base
- High tight flag
- 3-4 weeks tight pattern
- Symmetrical triangles
- Pullbacks to the 10wk line
- Short strokes
- Square box base
- Saucer with handle
- Decreasing volatility base
- Inverted Head and Shoulders
- Ascending triangles
- Bump and Run
The bearish setups we look for include:
- Head and shoulders
- Descending triangles
- Late stage base failures
- Double tops
- Rallies into intermediate resistance
Explanations of all of these patterns can be found in our glossary.
After compiling our list of stocks that are setting up, we are now ready to analyze them and rate them.
Step 2: Rating Setups
On average we find about 50 stocks that are setting up in primary and secondary patterns. That’s a lot of stocks and because we’re not going to be able to trade all of them, it’s important to find a way to consistently rate these setups.
We’ve seen plenty of checklists and those are a good place to start. However, the problem with checklists is that they inherently give everything on the list equal weight and not everything deserves to be weighted equally. It was for this reason that we created our own Stock Evaluation Guide which includes weights for all the criteria we’re interested in.
The Stock Evaluation Guide considers elements within these 4 broad categories:
- Chart pattern
- Industry Group
**You can read more about the Stock Evaluation Guide and download it for free here.**
All stocks that are setting up in primary base patterns get put through our Stock Evaluation Guide. It is within a stock’s base that the market is still determining if the stock is ultimately going to move up, down, or continue sideways and we are therefore most critical of stocks in primary base patterns.
Once a stock breaks out of its base, it is already beginning to prove itself and is therefore no longer subject to the guide. These stocks are evaluated based on the strength of their move, price/volume action, the potential reward:risk, etc…
All stocks making it onto the Ready List should have their daily/weekly charts fully annotated outlining the base, various support and resistance levels within the base, and any advanced pivots. It is here that we are able to determine the potential reward:risk of a trade defined by how close we’re able to enter on a pivot vs how far away the closest level of support is.
Step 3: Ranking Setups
[su_rectangle_ad_left]This is the easy part. The Stock a Evaluation Guide generates a score. We simply sort the scores from highest to lowest and that provides us with our rankings. When there is a tie, we look at the industry group as the tie breaker.
In practice, a stock with a score of a 10 vs a 9.7 may not have much difference at all. It’s when we compare stocks with a score of say 9.5 vs an 8 that we see the differences between them much clearer.
Note that a Rank or Rating doesn’t mean that a lower ranked/rated setup can’t outperform a higher ranked setup. All the Rating does is provide a composite of the flaws we have found within the stock per our methodology.
Gauging Market Health
These lists provide us with a valuable source of insight into the overall health of the market, at least per our methodology. Stocks setting up are a large part of what is needed to fuel an uptrend. When there are a large number of stocks setting up, it is one indication that it may be time to step up our trading. When the lists contract the market is telling us that it is time to dial our trading down. We observe these lists overtime and they produce their own trends. This exercise is a large part of what helped us sell out our long positions 2 weeks prior to the August 2015 crash and begin shorting ahead of it.
Here is an outline of the information we can gather from our lists:
- Expansion/Contraction: the greater the number of setups, the more fuel the market has to breakout or continue trending
- Number of Setups from each Sector: a large number of setups from a particular sector often indicates an imminent move in that sector)
- Average Stock Evalautuon Guide Score: tells us if setups or strong or if there are numerous flaws such as late stage bases, laggard groups setting up, etc…
- Performance of Stocks Setting Up: how is the market treating fresh setups? Are they breaking out, stalling, not breaking out at all?
- Advance/Decline of Setups: the number of stocks advancing and declining from the ready list viewed over time
We always want to trade with the broader trend of the market but it’s the stocks that we’re interested in that have made it to our lists that will ultimately guide us into or out of the market. They are one of the main ingredients in the secret sauce of gauging market health.
Thanks for reading! If you have any questions, please leave a reply below.