Swing
trading is a style of trading that attempts to capture short to
medium term gains in a stock over a period
of a few days to several weeks.
Swing traders primarily use technical
analysis to look for trading opportunities. Let’s find out how to pick stock for swing trading.
Always align your trade with the overall direction of the market.
The overall direction of the market is best measured by the Index. Whenever I am discussing trades and trends, I begin with the market’s primary and intermediate trends as measured by the Index.
These trends provide the context in which every trader must make short-term trading decisions.
If you focus only on the short term, even if your trade is successful for a limited time period, the larger trends are apt to reassert themselves.
At best, your profit potential will be limited. As such, you need to identify the longer-term trends to make sure you go with the flow and not against it.
Over the years, I’ve observed that “surprises” such as news announcements, analyst upgrades/ downgrades and earnings hits/misses almost always occur in the direction of the larger trends.
Traders should always be cognizant of where the Index stands in relation to its longer-period moving averages, such as the 40, 30 and 10 week.
Go long strength, Go short weakness.
Once you know the overall trend, do not fight the tape. Look for long trades during periods of bullishness. Find appropriate short trades during periods of bearishness
Let’s assume for a moment that the bear is on the prowl. The 40 and 10 week moving averages are both sloping downward and the Index is beneath both. In this scenario, you should always look for stocks to go short, NOT to go long.
When possible incorporate Price Relative to the Index into your chart analysis. This indicator will tell you how the individual stock is performing in relation to the overall market.
During bear markets you should seek out stocks whose relative strength line is trending downward in relation to the Index. Do the opposite during bull markets.
Always trade in harmony with the trend one time frame above the one you are trading.
We’ve all heard the cliché- “the trend is your friend.” But which trend are people referring to?
Use moving averages to be in tune with both the short and intermediate term trends, even through as a swing trader you are only trading for the short term.
Many short-term traders focus their technical analysis exclusively on the short-term chart.
However, this type of technical analysis will always end up being partial or limited because these traders can’t see the big picture
On the other hand, you should not focus exclusively on the primary trend when swing trading.
Even in a bear market, there are periods where the intermediate trend turns positive and stocks soar. These bear market rallies can be enormously profitable. Meanwhile, volatile stocks with high “betas” can move much, much more than this.
Even though you are a short-term trader, it is vital to know when the intermediate term trend is changing and a counter trend rally is taking hold.
Never trade only on the short-term chart of the swing-trading time frame.
Be sure to synthesize the messages that the weekly, daily and even hourly charts are telling you.
Use your telescope as well as your microscope when you look at charts. Too small a look back period using the microscope only can be deceptive and costly.
My first step when analyzing a stock is to look at a two year weekly chart. I examine the shares in relation to a long-term moving average and determine the overall trend. This weekly chart is ideal for examining the big picture.
Next, I focus on the 6-month daily chart. Here, I can see finer details that the weekly chart obscures. I use much shorter-term moving averages to ascertain the stock’s short-term trend.
Finally, I often hone in on the hourly chart to discern the prevailing trend over the last couple of weeks. Again, moving averages are extremely helpful here.
My final step is to synthesize all of this analysis. Is the stock telling me a clear, relatively unambiguous story?
Are the shares breaking out from resistance or breaking down from support with confirmation from volume and other indicators such as RSI?
Is this story sufficiently similar in all three time frames? Have I interpreted the story early enough so that I can go short or long with solid profit potential and minimal risk?
Not all stocks communicate clearly. In fact, some remain in extended periods of sideways consolidation.
A symmetrical triangle formation, for instance, is almost impossible to predict and trade.
Similarly, an MACD that gives signal after signal in a short period of time is a totally unreliable indicator.
Try to enter the trade near the beginning of the trend, not near the end.
It’s never too late to hop on the elevator. If the market is headed from the 95th floor down to the 78th, you can still profitability go short on floor 83.
But the quicker you recognize a trend has begun, the more profitable your trade will be and the less risk you will assume.
The earlier you pick up on the change in trend, the less risk you will take and the greater your profits will be.
The most important step here is to pay close attention to the overall market averages. When they are overbought or oversold, they are usually prone to reversal.
Researchers and analysts have developed a variety of indicators to detect when the broad market is prone to a reversal.
Some of these include the McClellan Oscillator, the Arms Index, the Volatility Index and the Put/Call Ratio.
When the market tests a major zone of support and resistance it is very useful to look at new highs and new lows and the advance/decline line.
Most “industrial,” or non-resource (papers, metals, oil, gold) stocks are highly correlated with the direction of the overall market.
Therefore, when the market turns they are likely to turn as well. Candlesticks and momentum indicators such as RSI and stochastic are what I describe as early warning lights. They often anticipate or lead a turn in the stock.
By contrast, trend lines and moving average crossovers are lagging indicators that merely confirm the message of the early warning signals.
Depending on your willingness to take risk, you can trade on either a leading or a lagging indicator.
When both types of signals have been given, you generally can enter the trade with a high probability of success.
Always apply the rule of “multiple indicators.” Do not trade on any one technical tool or concept in isolation.
Highly profitable trades usually occur when all available technical tools give the same message.
Candlesticks, volume, moving averages, and indicators such as stochastic and MACD occasionally all align to communicate the same message the stock is about to sharply rise or fall.
Remember: There is no magic bullet for profitable trading the market. As I noted in my first trading lesson, technical analysis can only increase the probability of your making a correct swing trading decision. Nothing is 100% accurate, and there is no such thing as “free money.”
Keep your eye on the ball. Track a consistent group of stocks.
You should also have a core group of stocks that you track daily and learn the personality of.
One of the first things I do when I check the market in the morning is focus on the financial news.
I go to a variety of websites to look up analyst upgrades and downgrades, earnings reports and guidance, what is happening in the overseas markets and with the price of oil, gold and the U.S. dollar.
I also look eagerly to see which stocks are active in per-market trading and usually add several of these to my regular tracking screen. I LOVE volatile, heavily-traded stocks.
In addition to these, however, I always follow a core group of regulars. I try to pick these from a large variety of sectors not just the volatile ones.
Several times a week, I look at their charts and make mental notes about breakout levels, prices at which they would make good trades, and so forth. Intraday, I watch how they behave and try to get a feel for their personality.
I call this “keeping your eye on the ball.” By tracking a comfortable number of stocks in a portfolio package, regularly checking the charts, following the news and analyzing company fundamentals, you will find yourself in a much better position to make winning trading decisions.
Always enter a trade with a clear trading plan, the four key elements of which are a target, a limit, a stop loss and an add-on point.
Swing trading can lead to impulse buying. Sometimes your impulses can turn out to be profitable, but other times they may not be.
Remember: without a clear plan you are merely gambling, not trading.
Capital preservation is key in trading. Therefore, it’s always vital to establish a stop-loss for each trade.
The best time to set one is right before you make the trade. If you are not watching the market intraday, then you should set this stop-loss with your broker.
If you are watching at all times, then I suggest you keep it as a mental stop, but execute it ruthlessly.
As a general rule, the maximum loss I want to take on any trade is 8% of the capital invested.
If there is no technical analysis basis for limiting the stop-loss to this amount usually a support level or nearby trend line then perhaps the market is informing you that your trade is late.
For most of my trades, I use market orders and normally trade very liquid issues.
And if I am watching the market, my order size is not large enough for it to be worth my while to fight over a few pennies in either direction.
On the other hand, if I am not watching the market and want to enter a trade based on overnight analysis, then a limit order is vital. Of course, if the market gaps, then I don’t want to pay too much and be behind the eight-ball from the start.
You’ll often come across times when a trade is going beautifully. You are watching the trade closely and have a very good instinct for the trading action.
You can almost feel the next price, you are that attuned to the shares. In those circumstances, why not add to your position? If you originally bought 1,000 shares, then you might want to add between 200 and 500 more.
When you add on, don’t pyramid, though. Remember: a sudden decline in the stock can quickly turn a healthy profit into a loss.
As a last general rule, I think it’s always a good idea to determine an appropriate re-entry point each time you close a trade (particularly when that trade was for a healthy profit).
Are you selling because the stock is in a strong uptrend, but you are concerned it will pull back? If so, then where is there sufficient support to allow you to get back in comfortably? Or if the market continues higher, at what price would it be worthwhile to re-enter your original position?
Try to put the odds in your favor.
Don’t risk a dollar to try to make a dime. On good trades, your chart analysis should always show more upside possibility than downside risk.
When you enter a trade you should always have a target price in mind. Do not pluck this target out of the AI though. It should be based on your technical analysis, using tools such as the measuring principle.
I always strive to select trades whose target allows me strong profits if I’m correct, but where my potential losses are fairly limited. In general, I look for opportunities where there are 1.6 to 1 odds.
Sometimes market conditions make this difficult. For example, toward the end of a large move in the overall market, a large part of the gain or decline in a stock may have already taken place.
If possible, however, I seek to find set-ups where I can meaningfully set a stop loss of 8% in order to capture a profit of 16%. When I cannot find those opportunities, I then look for potential 12% gains while risking just 8%.
A swing trader should always assess and reassess the chart. In many cases, you may need to take profits before your target is hit.
On the other hand, if your analysis leads you to conclude that your target will be exceeded, then you may want to raise that target.
The key to trading success, as many successful traders have proclaimed, is to cut losses short and let profits run. Unfortunately, many untrained swing traders instead let losses run and cut profits short.
Master the “inner game” of swing trading. Great trading is psychological as well as technical.
Always keep a positive mental attitude about your trading. Do not let bad trades affect you longer than necessary. Learn from your mistakes; poise yourself to make your next trade.
Countless times I have heard traders beat themselves up over a bad trade they’ve made.
I would have bought XYZ at the bottom, but I had a doctor’s appointment that morning. I should have sold.
Why didn’t I sell? I could have been out right at the top, if only I had read the candlesticks correctly. When am I going to learn?
Making a trading mistake can be painful. Not only does it often result in a loss of trading capital, but it also hurts one’s self-esteem.
When this happens to me, I literally think of it as a form of “grief.” The most productive response I can have is to experience the feelings of disappointment or hurt and then move on.
After all, I need to get mentally prepared to make my next trade. I always try to treat bad trades as a learning experience.
Was there something I didn’t see on the chart that I should have? Did I enter the trade too late?
Set my stop too close? The winning trader is RSI persistence: the commitment to getting better and better through time.
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