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As the market flourishes with each bull run and both prosperity and risk appetite grow in our country, a new wave of young traders—agile and full of enthusiasm—are entering the stock market with dreams of transforming their own lives and those of their loved ones.
However, the stock market has never been easy—even with all the technological advancements and the widespread availability of knowledge that was once hard to access. Most newcomers soon face their first major hurdle: getting lost in the overwhelming noise of conflicting ideas and contents, which prevents them from focusing on a single approach that could actually help them navigate the market.
Every week, I receive numerous messages from people—as young as 18—seeking guidance on how to start and grow in trading. A few weeks ago, I wrote an article on avoiding fatal mistakes in trading. Continuing that series, today I’m sharing a step-by-step guide on how to create a Setup Playbook that will help you master a setup and gain absolute mental clarity around it.
However, before diving into the step-by-step process of building a playbook, I’d like to challenge a common belief—that some setups inherently have an edge while others do not, and that this edge is something measurable.
This entire notion of setups having an edge stem from the idea of trading based on indicator signals—like RSI crossing a certain level or fast stochastics crossing the slower one. Traders who rely on such strategies often try to backtest them to identify a repeatable edge that these signals might produce over time. With the growing popularity of price action in recent times, many traders have started applying the same backtesting approach to chart patterns in an attempt to identify an edge.
However, this approach is fundamentally flawed as it contradicts the core principles of market dynamics. It also fosters a false and misleading belief, leading traders into an endless pursuit of finding a setup with a guaranteed edge. This, in turn, causes them to question the setups they already know when faced with failure due to adverse market conditions.
Setups don’t have an edge. The moment we claim they do, we mistakenly attribute the outcome to the setup itself. The true cause behind major price movements in the market is liquidity, and those who control a large portion of this liquidity don’t act based on setups. They act on value, and the resultant price movement depends on three factors: how much value is unlocked, how much of it is already priced in, and how quickly it is being discounted. None of these factors can be measured or quantified.
When people claim that a flag has a 65% win rate based on some backtested data, I have a few questions for them:
What exactly is a flag for you? What you consider to be a flag might only represent one depiction of a flag, not the flag itself. A high-tight flag is just one variation, but there are many other techniques where people trade similar patterns with different names. A trader could be trading a flag in crypto or forex on a one-minute chart on the short side, and they don’t necessarily need to understand what a high-tight flag is or even know who William O'Neil is.
What do you consider a win? When you say a flag has a 65% win rate, what exactly does that mean? You might be measuring a 1R or 2R move as a win, while I may define a win as a 10R move. Even closing a dollar above the entry could be marked as a win. So the win rate varies significantly depending on how you define a "win."
What about failure? What stoploss did you use? And how does that win rate change if we adjust the stoploss criteria? A change in stoploss can drastically alter the entire outcome of a backtest.
What about the key qualitative aspects—like the strength of prior demand or the broader context in which the flag is forming? A flag forming as a follow-through to an early-stage EP setup will likely have a completely different outcome compared to one forming during a climactic move. Ignoring these nuances leads to backtests that are not just unreliable but also misleading.
There are hardly any backtests that conclude a strategy doesn’t have an edge—mainly because of how risk-reward skews the result the moment you fix a stoploss and target multiple Rs or even have an open target. Even a simple coin toss can show a profitable edge if you lose $1 on tails and make $2 on heads. The profitability doesn’t lie in the pattern—it lies in the payoff structure.
Our mind is fundamentally a pattern recognition machine. When you spot a familiar face in a crowd of hundreds, your brain has already compared that face against thousands of others you've seen in your lifetime. That's what enables you to recognize it—and in that moment, your mind instantly begins retrieving associated information like the person’s name, occupation, or your relationship with them.
An observation or idea—something we notice once—starts to become a pattern the moment we observe it a second time. But the real edge doesn’t lie in the repetition alone; it lies in the subtle nuances that create variations. It's the ability to interpret these differences based on the context in which the pattern appears, and how those contextual shifts relate to the eventual outcome.
Before returning to the topic of creating a trading playbook, another important question arises—how do you find a setup?
Setups and strategies are like commodities; they’re widely available, and most traders use similar ones with slight variations depending on their interpretation. You can discover many effective strategies, especially for short-term trading, through the work of Pradeep Bonde. Some of these can even be adapted into positional strategies. However, minor modifications may be needed depending on your country’s regulations or your specific trading objectives.
However, knowing a setup and truly acquiring it are two different things—and this is where creating a trading playbook makes all the difference.
You’ll need a note-taking app that allows easy insertion of charts. I personally use Evernote, but you can go with Notion, OneNote, or whichever feels most comfortable. The key is that it should be simple to use and not impose limitations that slow you down. I also prefer paid versions of such tools when needed, as they save time and effort—something I strongly recommend to anyone pursuing trading as a serious career.
Another important principle is to focus on one setup at a time. Identify a setup, observe its key behavioral traits, and dedicate at least six months to trading it and collecting relevant data. Only after building a strong understanding you should move on to the next. Over time, this will help you build a solid arsenal of setups—with variations—that can be applied across different market conditions.
Step-by-Step Approach for Creating a Setups Playbook:
Define your setup in one line - In the start-up world, investors often ask founders to define their purpose in a single line—what problem they’re trying to solve. This helps gauge the founder’s level of mental clarity and understanding of their mission. We apply the same principle here—can you define your setup in one clear line? What exactly are you trying to capture, and why should it logically lead to a profitable outcome? Remember, trading demands brutal honesty—use this moment to uncover gaps in your understanding. Don’t try to gloss over them just because you’re eager to move ahead.
Insert a model setup formation as a visual reference - This can either be a hand-drawn sketch or a chart example—that clearly replicates the exact structure you aim to identify in real trades.
Identify the key qualitative aspects of the setup - Try to identify a maximum of 2 or 3 key qualitative aspects on which your setup selection will depend. While additional secondary traits may exist, limiting your core decision-making to these few aspects helps simplify the process. These can be contextual, setup-specific, or entry-related, and should be highlighted or marked within the model setup you included earlier.
Develop scanning criterias - Identify one or at most two non-negotiable criteria on which your scans will be based. Run these scans within the stock universe you intend to trade, ensuring it aligns with your liquidity requirements (as explained in the "Total Universe Scan" from my podcast with @Charts_Maze
Link
Create a Watchlist Management Framework - Watchlist management helps define how we select, identify, and track potential setups after scanning. Some stocks are ready to trade, some need a little more time, while others are only context-ready and require significant time to develop a complete setup. You must categorize and monitor them closely based on their stage.
Identify Trade Management Rules - Attempt to identify the purpose and potential of the setup and assign a suitable trade management framework accordingly. I personally use three template frameworks—Velocity, Magnitude, and Hybrid—based on the intent behind the trade. It's also important to keep your trade management rules limited to four or fewer to ensure simplicity and ease in execution. You can learn more about this in detail through my Process Flow webinar -
Build a Historical Database - Building a historical database of setups and tracking their performance post-breakout can provide deep insights. Always save at least two charts—one excluding the breakout candle to avoid chart compression (read more - Link) and another showing how trade management should have played out. If the entry was based on an intraday chart, include that as well. Adding a brief commentary alongside each example will sharpen your understanding of subtle nuances within the setup. This database should be updated regularly as new trades emerge and can be divided into two sections — trades we executed and trades we missed.
I often see people obsessed with building a massive database going back to the early 2000s or even to the inception of the NSE. However, my experience while developing the Market Breadth Monitor V2.0 showed me that very old data adds minimal incremental value compared to the huge effort it demands. Moreover, nothing can match the benefits of live market experience — the emotions, urgency, and hesitation we face in real-time.
Another observation I had is that the markets have changed significantly over the years — even compared to 2016–17 — especially in terms of liquidity and the speed at which information spreads. Hence, the database should focus on having enough samples to capture the most common occurrences, without getting obsessed over rare situations that don't appear frequently.
As a rule of thumb, I prefer to include at least one complete bull and one complete bear market in my database, along with two or three transformation phases, such as a bear-to-bull or bull-to-bear market transition. However, different setups have varying frequencies. For instance, you could observe up to 500 momentum burst setups in a year, which would provide more than enough sample size to understand the setup. Therefore, the time duration for building your database should be determined according to the nature of the setup itself.
To understand how our setup would have performed under unique circumstances or to analyze which types of setups emerged after specific events in the market, such as the Covid crash, a separate study should be conducted for that particular time frame. This focused study helps in gaining insights into the behavior of setups under extreme conditions and can offer valuable lessons for future trading strategies in similar market environments.
Some traders may choose to focus solely on the setup in their Playbook and skip the broader process flows such as trade management. For them, steps 4 to 6 can be considered optional and may be excluded as per their preference.
However, the true value of a playbook lies in how effectively we derive insights from it and deepen our understanding of the setup. Build a feedback loop to refine your process flow, continuously improving and simplifying decision-making by eliminating unnecessary steps.
Reference Posts That Can Be Helpful:
Deep Dive (Part-I) - This post will help you understand how to create scans for a setup and build a database based on it for developing your playbook.
Situational Awareness Webinars (Part-I & II) - The "Know Your Setups" sections in these webinars will help you gain deeper clarity on my process flow, the setups I trade, the scans I use, and how I assign trade management strategies to them. Links for
&
Case Study
- This case study on Shankara Buildings IPO in 2017 greatly helped me define what an ideal
should look like. Similarly, we will create a model setup for each Playbook we build.
Feedback Loop - This excellent article by
on creating effective feedback loops will greatly help you understand how to derive insights from your playbook and use them to improve performance in future trades.
Process Flow Webinar - This webinar, conducted for the members of the Mumbai Chapter of my group, will help you understand how to build routines and trading plans to create an executable process flow.
With this, I sign off from this article. I hope it adds immense value to your approach and helps you gain greater mental clarity around the setups you trade. Maybe in the future, I’ll also add a whimsical mind map with all the steps for quick reference.