The first of a series of trade setups I will be posting…

My scan of the S&P 500 stocks looking for good risk to reward trades involves me using the grid feature in Prophet Charts (also part of Think or Swim trading platform which I use myself). One of the most important rules when looking at a stock is to view the big picture. The chart shown here is a grid of Estee Lauder with four different views. The top left is a multi year chart, top right is more recent years, bottom left is a 1 year chart, and finally the bottom right is an hourly chart.

Although I do look at many technical indicators, I concentrate on price support and resistance as the primary selection criteria first. After I find something of interest I will apply some other indicators to disprove a theory, or back it up.

In the case here of Estee Lauder (EL) I like this for a ’short’ trade. Observe that there is significant price resistance (gray rectangle) in the region of $36. I will be looking to initiate a short position in Estee Lauder if the price gets to the gray rectangle.

Why wait you may ask? If I am confident that Estee Lauder will be going lower over time then why not just short it now. The reason why traders wait is to obtain the best risk to reward setup as possible.

In the case of Estee Lauder we have strong price resistance around $36. By waiting for the price to get to this area we are providing our trade with a clear exit point that is not far from our entry. So for example, if Estee Lauder does make its way up to the $36 area and then begings to hesitate then we have confirmation that the resistance level is impacting the price movement. That is the ideal time to initiate the trade. This gives us a claer exit should the trade go against us. Which in this case would be a break above the price resistance (gray rectangle). The closer you initiate a trade to your exit point, the better your ability to control your losses.

The best traders always wait for a trade to come to them, they never go chasing after it with no exit stragety in place.

With Estee Lauder being tightly connected to the retail sector I do expect to see continued weakness throughout this sector for some time to come. The price target for this trade would be a drop back down to price support (black line on upper left chart) which is $25. Estee Lauder has good average volume (the higher the average volume is the better). You would not want to swing trade a stock that only has 300,000 daily volume.

If you are new to trading I recommend you understand some basic of portfolio sizing basics.

First rule: NEVER put all of your trading money into one trade.

Each trader has different amounts of capital to which they are working with. If you are just starting out then you should never try to manage more than ten trades at any one time. Give yourself time to learn the ropes and trading basics. Too many open trades at any one time can be overwhelming.

As you grow your portfolio you can adjust your position sizing to allow for more trades at any one time, but only after you have your style nailed down and proven.

There is another reason why we never put all of our capital into one trade at once. And that is too keep losses on your total portfolio down to a manageable level. For example:

Lets say yo have $20,000 in your trading account. And you put all $20,000 on a single trade. If that trade does not go as planned and you get stopped out with a loss of 4% than you have lost $800 on that one trade.

Now, if you had only put $2,000 into that trade and took a 4% loss then the damage to your total portfolio is only $80.00. Money management in trading is very important to staying in the game and winning in the long run. It may seem tempting to ‘go all in’ and try to hit the jackpot. But, that is the quickest way to go broke and be on the bench watching the game instead of playing it. Building up ones portfolio slowly may seem boring, but it is the best way to build up capital and stay in the game. Remember, as you build your winnings you are able to put more in the next time and still stay under the 10% rule.

The 10% rule is good for begineers, as you get more advanced, you can increase the amount allocated to any one trade… BUT, one should never put more than 10% of their total money into any single trade.