The Five Star Strategy Breakdown
What is the Five Star Setup?
The Five Star Setup is more than just a setup. It’s the basis of my analysis, whether it comes to directional trades using the squeeze, pre-earnings trades, earnings trades, Fibonacci analysis, and more. It’s the high probability approach that I use to identify setups that are better than the rest. I do this by combining multiple high-probability factors into one core idea.
This is because an idea with many points of confluence is always going to be stronger than an idea that stands on a single leg. As such, I go into all of my decisions with the idea that setups must be ranked. I rank them by giving them stars. Each category is deserving of a star. Without at least three, the setup is a no-go. Four and five stars have the best chances of success.
The points of confluence I look for are:
- Macroeconomic Backdrop + Fundamental Alignment
- Relative Strength or Relative Weakness Leader
- Existence of a Directional Trading Setup (Squeeze, Earnings Hot Zone Stats, etc.)
- A Five Star Trend
- An Entry with an Edge + an Identifiable Target
Sometimes tickers will have even more than Five Stars. These are the setups that generally earn the most risk.
I use my system for everything. Without a system to rank potential market opportunities, how would you know which has the worst potential or most deserving of your money?
Ranking for Risk Parameters
Arguably the two most important reasons to rank your trades are:
- To identify whether or not your idea has a good probability of working
- To make a decision on how much risk should be involved
When I first began trading, I was learning from my mentors and I struggled to understand how or why they put a specific dollar amount of risk into a trade or a certain percentage of their account.
This decision can be emotional, but it’s best for traders to cut out emotion as best they can. So, how can you cut out emotion when placing your money on the line?
Use a rating system. It either gets a good grade, or it doesn’t.
It’s an objective method of measuring probability so that you can remove your emotions from the equation — because your emotions will betray you.
Five Star Timing
I approach the market looking for opportunities. Sometimes, those opportunities come in the form of long-term buy-and-hold investments. Oftentimes, they are a typical, directional swing trade that I’ll be in for 1-3 weeks. During earnings season, I’ll frequently get in trades at market close and get out the next morning. It’s a rare occasion in which I day trade, but these ideas can be used in that vein as well.
For a typical Five Star, directional swing trade, I will analyze the monthly, weekly, and daily chart time frames. This means the setups I find will keep me involved for 1-3 weeks. But the significant part about this timing is that it’s what works best for me.
I use this time frame because it fits my lifestyle well. Over the years, I have discovered that there is nothing quite like making sure trading fits within the life you are continually making.
I like this time frame because I find it’s the sweet spot between being jittery in short-term trades and getting impatient while waiting for a setup to play out.
With this time frame, setups also don’t need to be managed every hour that the market is open, so I’m free to have lunch with the kids or appear on a show without worrying too much about what I missed while I was gone.
Of course, this also depends on what kind of strategy I use.
Five Star Trading Strategies
There is a long list of trading strategies that can be used with the Five Star Setup. Which one to use depends on your trading personality, risk tolerance, market conditions, and more.
I use a variety of trading strategies, including:
- Investing in stock & ETFs long-term
- Trading stock
- Buying calls and puts
- Selling credit spreads
- Buying debit spreads
Even within the trading strategies I use, I’ll select different ones at various points in the market. The trading strategy I ultimately select depends on how highly I rate the setup, the additional risk I have on, market conditions, and more.
Making a Decision — One Star at a Time
The Five Star Method is a baseline, top-down method of analysis that identifies trading and investing setups across time frames. It’s an overall process and way of thinking about the market.
What does it look like in practice? I start with the Big Picture View of the market, and I ask myself these questions:
- What is the story that the market is telling us right now?
- What kind of market condition are we in?
- Which indexes, sectors, and stocks are in focus, and why?
- Do the fundamentals align with these ideas?
- Are there any trading setups within this framework that fit the general idea?
- Are those trading setups aligning with the trend, an entry with an edge, and an identifiable target?
Once my idea passes the Five Star test, the question of how to use it to trade is naturally what comes next!
All in all, the most critical aspect to remember is that opportunities in the market come with varying levels of probabilities. There isn’t a method to ensure your ideas will work 100% of the time, but everything you do should be working to improve your edge continually.
Starting with a top-down, big-picture view and running each setup you have through this lens while looking for the highest level of confluence between varying ideas is how I do just that.
Each data point that tells you your setup is a good idea earns it a star. Without at least four stars, there isn’t enough confluence to mean your setup has an edge.
So, next time you’re going to place a trade, ask yourself this — “Is it a Five Star Setup?”
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