A Pre-Trade Filter That Turns Down Most Setups on Purpose

Most of the setups on a watchlist should not be traded. That’s the premise, and the filter makes it mechanical. You write down the checks in advance, run every candidate through them, and treat a single failure as a pass.

Nothing more to it.

The chart tests from the previous lesson on weak setups are the start. The rest cover what the chart can’t show you.

The checks

Each line gets a yes or a no. There is no “mostly.”

• Trend. The stock is moving in the direction of the trade on your timeframe and the one above it.
• Level. The entry sits at a support or resistance level where the stop has a clear place to go.
• At least 2R. Room to the first obstacle measures at least double the risk between entry and stop.
• Liquidity. Volume and the bid-ask spread meet the minimums you set for yourself, so getting out at your stop costs roughly what you planned.
• No earnings inside the holding period. If the company reports before you expect to be out, the stock can gap straight past your stop on the report, and a gap like that turns a planned 1R loss into whatever the opening price says.
• Room in the total risk budget. Adding the trade keeps your combined open risk under the cap you set.
• The reason in one sentence. If you can’t write it, you don’t have one.

Some of these take seconds. The risk budget takes a minute of arithmetic, and the answer on adding up the risk on all your open trades shows how to total it.

Any single failure means pass

This rule makes the filter work. A checklist that tolerates one miss soon tolerates two, and from there it drifts, week by week, into a list you read after you have already decided to buy, which filters nothing. The strong-looking setup that fails one check is the one the rule exists for.

You will pass on trades that would have worked.

Candidates A, B and C through the filter

Take a hypothetical account with a total open risk budget of $1,500. Current open trades risk $900. Each new trade risks $300.

Candidate A is an uptrending stock pulling back to support. Entry $40, stop $38, next resistance $43. Trend passes and so does level, but the room is short.

Candidate B is a stock in an uptrend, at a level, with entry at $60, a stop at $57 and resistance at $69, which is $9 of room against $3 of risk, or 3R. It’s liquid. The plan is to hold for up to three weeks, and the company reports earnings in the second week, which is a failed check, so the trade is out however clean the chart looks and however good the reward to risk.

Candidate C is retesting a breakout level in an uptrend. Entry $25, stop $24, the prior high at $28.

C is liquid, and its next earnings report falls after the planned exit. The reason in one sentence: a retest of a breakout in an uptrend, with 3R to the prior high. Every line is a yes. C is the trade, and the position size calculator turns the $300 risk and the $1 stop into 300 shares.

Where the filter needs care

A filter only works if the thresholds are yours and written before the market opens. Changing the 2R minimum to 1.5R because a setup looks good is the filter failing in slow motion. For practice finding the weak spot in a trading plan, the Poke a Hole in the Plan quiz runs plans through the same kind of scrutiny.

Some weeks the filter will clear nothing at all, even though the setups themselves look fine, and the next lesson covers the market conditions where that is the right answer and where the better move is to trade at a smaller size or not at all.