Little, Trend Trading Set-Ups

If you’ve read L. A. Little’s previous book, Trend Qualification and Trading, which I reviewed last year, you can skim through the first part of Trend Trading Set-Ups: Entering and Exiting Trends for Maximum Profit (Wiley, 2012). Essentially, Little introduces what he calls neoclassical technical analysis based solely on price, volume, and time. No squiggly lines, no patterns. Neoclassical technical analysis relies on the distinction between qualified and suspect trends for trade direction, anchor bars and zones for timing, and a trading cube that “offers a visual of the qualified trends across the differing time frames for a stock, its sector, and the general market it is part of as well as the inherent relationships between these three related components.” (p. 56)

In the second part of the book Little moves on to the task of formulating a trading plan and finding the highest probability trade set-ups.

Part and parcel of any trading plan is determining position size. But since in trading nothing is black and white, when trying to figure out trade size it can be misleading (and dangerous to the bottom line) to plug some numbers into a ready-made model and then confidently go full steam ahead. “Knowing when the probabilities for success are significantly greater than failure affords the market participant the luxury of making comparatively outsized trades in such situations. Money is made in the markets in bundles most of the time. It does not just arrive day in and day out. In fact, it usually leaks out rather than leaks in. Being able to make a larger bet when the probability for success is greater while at the same time the reward-to-risk of the trade is quite favorable is the Holy Grail of trading.” (p. 100)

So how does a trader identify high probability set-ups? First of all, there are only two basic trade types—breakouts and retraces. But there are seven possible and related scenarios for these set-ups, which I can’t possibly describe in a brief review. These scenarios are “tightly coupled” around the concept of retest and regenerate. “The term retest and regenerate was first coined to describe the common and repetitive situation where a swing point is broken and a suspect trend created (volume does not expand on the break). In the ebb and flow that accompanies most markets and stocks, it is overwhelmingly probable that when a stock breaks out under such conditions it will, after some period of time, retrace back to the area where it broke out to retest.” (p. 115) It is turns out that this is true not only of suspect trends but of confirmed trends as well.

The author has done extensive work to assign probabilities of failure to each of these scenarios. For example, the probability that a confirmed bullish trend will fail when a retest and regenerate sequence occurs within six bars of the breakout is 19.86%. For a suspect bullish trend, the probability is 11.35%.

Little provides trade entry decision ledgers for a range of scenarios. They are essentially checklists where, if a certain number of items is true, it is then appropriate to check the potential reward versus risk to make a final trading decision.

Trend Trading Set-Ups is a clear testament to the principle that trading is simple (although not too simple) but not easy. I don’t know what a good trader’s track record would be following Little’s method. I can say, however, that it’s a thoughtful, plausible approach to trading. And I don’t say that too often.