5 Consistent Day Trading Setups to Pursue Profit

Paying Attention to Patterns Can Lead to Positive Returns

Despite the fluid nature of each trading day, there are price patterns that can recur and signal trading opportunities to investors who know what to look for. Those changes in daily prices that seem random could actually be indicators of trends that day traders can take advantage of.

Along with spotting a pattern, it is necessary to understand price action and realize when a group of traders has gone long or short and trapped themselves. Such a situation is likely to cause a price to surge in a particular direction when traders are forced out of their trades.

Trade setups can often occur at these "emotional" points where a group of traders reacts to mitigate their losses or gives in to their greed.

The following five day-trading setups or entry strategies have a tendency to emerge in the market at some point on most days. It is plausible to see at least one or two of these setups occur each trading day. This does not necessarily mean all of these patterns will take shape on the same day. By learning to recognize these trading setups, it is possible for a day trader to take actions that could improve their chances of seeing a profitable return.

Impulse-Pullback-Consolidation Breakout

day trading setup in trending direction

A​ trading session often begins with a strong move, called an impulse wave, in one direction. This usually occurs within the first five to 15 minutes after a stock opens for trading. The price may pull back and stall out, forming a consolidation where the price moves sideways for two or more minutes. This consolidation should occur within the range of the impulse wave. If the price falls off the open, the pullback and consolidation may occur below the opening price. 

Based on the direction of the initial impulse, wait for a breakout from the consolidation in that same direction. A breakout in the opposite direction of the impulse isn't traded. For example, if the price rallied off the open, then pulled back and consolidated occurs above the open price, wait for the price to breakout above the consolidation. That should trigger a long trade. Enter long one cent above the consolidation high point (or one cent below the consolidation low if a short trade develops).

The consolidation should be relatively small compared to the impulse wave that preceded it. If the consolidation is large compared to the impulse wave, the pattern is less effective. There should be a distinct impulse wave, a distinct pullback, and a distinct consolidation during the pullback. If each of these parts is not distinct from the others, the pattern is less effective and should be avoided.

This pattern could occur throughout the day. As a trend-following strategy, this can be used during most time frames and in most markets. Keep in mind that the most significant moves in a market typically occur near the open. Catching the first trade of the day with this strategy can have a substantial impact on overall profitability. If this pattern occurs later in the day, it will often produce smaller price moves (compared to trading near the open).

Reversal-Consolidation Breakout

reversal day trading setup

Not every impulse is followed by a smaller pullback and consolidation. Sometimes you get a big move in one direction followed by an even bigger move in the opposite direction immediately after. This is called a reversal. In this situation, put your focus on the most recent major move. 

For example, assume the price drops $0.20 off the open. It then rallies $0.30. Don't be distracted by that first drop; it doesn't matter anymore because you now have an impulse to the upside. Your focus should be on watching for the price to decline a bit (pullback) and then consolidate. If the price breaks above the consolidation (one cent), go long.

The same rules apply as in the previous setup. Wait for a pullback in the opposite direction of the impulse. The pullback must be smaller than the impulse. Then wait for a consolidation and a breakout of that consolidation in the impulse direction.

Reversal at Support/Resistance

day trading setup 3

Support or resistance levels may be represented as a horizontal or diagonal line, as a situation where the price has reversed off this line at least two times before (including the starting point of the support/resistance line). 

It's important to note that support and resistance are often areas, not an exact price. Therefore, when looking for a trade setup near support or resistance, the setup doesn't need to occur exactly at support or resistance. Rather it can occur slightly above or below.

The support or resistance tells you to be on high alert because a reversal or breakout could be close at hand. With that information, wait for a consolidation near support or resistance. You have a trade signal if the price breaks above a consolidation near support, or breaks below a consolidation near resistance.

If a reversal signal occurs, take the trade when price moves one cent above the consolidation near support or one cent below the consolidation near resistance. Expect the price to bounce off support or fall off resistance if this pattern occurs. If the price instead breaks above the major resistance area (and consolidation) or breaks below the major support area (and consolidation), get out of the trade immediately, and consider taking a breakout trade if applicable.

Strong Area Breakout

day trading setup where price breaks resistance/support

Trading a breakout above a major resistance area or below a major support area may be popular strategies but this can also be extremely challenging. Having this strategy in your tool belt can still be useful for when special situations arise. 

The basic idea is to watch for levels that pushed the price back in the other direction multiple times. For example, a price might rally and reach $25.25 but then falls. It may do this several times yet is unable to break through the level. After the price has tested that area more than three times, you can be assured lots of day traders have noticed this. All of a sudden, if the price is able to reach $25.26, that could signal an important shift.

A breakout does not guarantee a big move. That is why this strategy should be used sparingly. Often the price will break an important boundary but fail to produce a significant move.

After the price has tested an area, it should make a visually noticeable move away from that area before returning to it. If the price stays near an area, without getting significantly rejected by it, then the pattern loses its effectiveness. In other words, you want to see the price get visually rejected by an area multiple times.

The power of the pattern comes from traders pushing the price back to that level (and eventually breaking it) despite the fact that the level sent the price in the opposite direction on multiple occasions in the past. The persistence of traders to repeatedly push the price back to and finally through that level shows they have more resolve than the traders going in the opposite direction.

False Breakouts Help Confirm Trades

day trading setup using false breakouts to confirm trade direction

By learning to recognize false breakout patterns, you can become more efficient at using other strategies for day trading. For example, if the price plummeted off the open and you are trading an impulse-pullback-consolidation setup, you might expect the price to fall again. A false upside breakout would help confirm this trade.

The price might have tried to go higher, and couldn't. If it then breaks out the bottom of the consolidation, you can pursue a short trade. With this approach, you would not have been trapped by the false breakout because you had no interest in going long based on the initial impulse to the downside.

This type of confirming false breakout occurred in the Reversal-Consolidation Breakout example. In that a case, the expectation was for a move lower after the pullback because the last impulse wave was down. The price consolidates but has a false break above the top of the consolidation. The price then falls out the bottom. You would've been waiting to go short anyway, but the false breakout in the opposite direction further confirms the trade.

If the price tries to go one direction and cannot, it is probably going the other direction.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.