Swing trading

Table of contents

Swing trading vs Trend trading

Notice in the chart below that there are two different paths between points ‘A’ and ‘B’.

The blue dashed line is obviously the shortest path and it also identifies the primary price trend.

Price tends to oscillate around its primary trend line or moving average and that is exactly what we are seeing here with price spending time both above and below the dashed blue line.

 

 

Traders have two choices for trading this chart:

1) Take a long position (buy shares) at point ‘0’ and hold the position until the projected Target price is reached at point ‘5’

2) Take a long position at point ‘0’ and close it at point ‘1’ – then stand aside (or go short) while price corrects from point ‘1’ to point ‘2’ – then take another long position at point ‘2’ and close it at point ‘3’ – etc…

Choice number one describes the Trend or Position style of trading.

Choice number two describes Swing trading.

The theoretical gains from Swing trading are considerably higher than the gains available in Trend trading.

Instead of the single Trend trade shown in this example (the dashed line between ‘0’ and ‘5’), the Swing trader has five opportunities to profit.

Styles of Trading

All types of trading are essentially the same whether we are talking about day trading S&P 500 E-minis or Swing trading the Precious metals mining stocks.

As Traders, we enter a position at one price and exit that position at another price sometime in the future.

Our profit (or loss) is the difference between the trade entry and exit prices less (or plus) trading fees.

When we start talking about all the different types of trading (day, swing, trend, position, buy-and-hold, etc.) the most observable difference is the length of time between Entry points and Exit points.

A less obvious, yet critical, distinction between trading styles is the entry, exit, and position management rules used for each.

For example, Day trading may have specific price levels for exiting with a profit or exiting with a loss (“bracket trade”), while a Swing trade or Trend trade might use a trailing stop order to both limit losses and maximize profits.

The table below lists some of the key attributes of well-known trading styles.

 

  Day Swing Trend or Position Buy-and-Hold
Duration Less than one day 2 days to several weeks Several months Until retirement (or forever)
PRO No overnight risk Max theoretical profit Less management Almost zero management
CON Higher trading costs

Risk of overtrading

Overnight risk while in market

Miss surprise moves while out of market

Overnight risk while in market Overnight risk while in market

This strategy ignores business cycles and sector rotation

 

In this article we will focus on Swing trading.

Swing trading Entry points and Exit points

In an ideal world the Swing trader would enter and exit her positions at the exact price bottoms (points 0, 2, and 4) and tops (points 1, 3, and 5) shown in the chart.

In reality, however, picking tops and bottoms is only possible in hindsight so some of the theoretical gains will never be realized.

 

“Only liars buy at the exact bottom and sell at the exact top”

 

Another limit on theoretical Swing trading profits is the fact that trading against the primary trend has a lower probability of success than with-the-trend trading.

Counter-trend price moves (corrections) are often quick and violent making them challenging to trade profitably.

Trading against the primary trend is only advisable for experienced Traders with an ability to monitor their positions and the Financial markets closely.

In the example we are considering here Swing trading exclusively with the trend means the downward legs from ‘1’ to ‘2’ and from ‘3’ to ‘4’ should not be traded.

Which means that instead of having 5 opportunities to profit, the conservative Swing trader only has three potential trades, all of them in the direction of the trend.

Even without the two counter-trend swings (1-to-2 and 3-to-4) there is still greater overall profit potential in Swing trading than in Trend trading.

Picking Price Tops and Bottoms – Is it Possible?

The short answer is, “No”.

We can however use Technical analysis to predict levels where an upward or downward price movement has a high probability of reversing or running out of energy.

Mainstream Technical analysis tools like Moving averages, Trend lines, Price channels, and Bollinger Bands can be useful for identifying potential tops and bottoms.

There are even more powerful and accurate tools available for price forecasting, although knowing when and how to apply them requires some knowledge and experience:

• Andrews pitchforks
• Fibonacci retracements
• Fibonacci extensions
• Elliott wave principle (EW)

At Satori Traders we use these advanced forecasting tools along with traditional Technical analysis to predict where the tops and bottoms of price swings are likely to occur.

Buy Low, Sell High

As traders we want to “buy low and sell high”, as the old adage goes.

The obvious challenge in following this advice is determining when price is “low” or “high”.

In hindsight these price levels become obvious as we can see in the chart below where price is making a series of higher-highs and higher-lows as it trends generally upwards.

 

The challenge, however, is to predict these high and low levels in advance.

Fortunately, there are some tools that help us do just that.

The most powerful tool in our trading toolkit is the Andrews pitchfork so that is where we start our Technical analysis.

Andrews pitchforks

An Andrews pitchfork is drawn from three Swing pivot points as shown in the chart below.

The modified-Schiff variation of Andrews pitchfork is being applied in this chart.

 

We can draw a pitchfork as soon as we have three Swing pivot points to work with. The fork in the chart above was drawn in early-May 2019 and confirmed in early-June 2019.

Notice how price reacted at the median lines of this pitchfork for the six months after the fork was drawn.

Clearly the fork identified significant Support and resistance levels where Swing trading entries and exits could be executed.

The fork continues to accurately describe the price action at the time this chart was published.

While we aren’t currently offering training in how to apply and use Andrews pitchforks, by following our work you will see the forks used for Swing trading over-and-over again.

Swing trading example

Let’s continue with the chart above and walk through a Swing trading example.

In this example we will assume that we have profitably traded the swing from point ‘2’ to point ‘3’ and now we are sitting on the sidelines in September and October waiting to enter again at Pivot point ‘4’, whenever it occurs.

The challenge is to determine where point ‘4’ is likely to happen, or at least determine a zone of high-probability where the Swing pivot point may occur.

As we can see in the chart, during the months of September and October 2019 traders had three opportunities to pick a bottom.

The first two “bottoms” were just pauses before the overall downtrend continued and any Traders going long at these points would have been stopped-out with a loss.

Notice in the chart that the Andrews Pitchfork showed us where price was likely to find support as it plunged lower.

Both of the first two “bottoms” occurred at one of the fork’s median lines and consolidated sideways for some time before heading lower.

Let’s consider some of the other advanced Technical analysis tools and see if they can help us accurately forecast a high or low price point.

Oftentimes the combination of tools will identify confluences of support and resistance where Swing pivot points are likely to occur.

Fibonacci retracement

The Fibonacci retracement tool shows us where price is likely to find support during a correction.

The most common retracement levels are 38.2%, 50%, and 61.8%. (Note that 50% is a common price retracement level and it is included on most Fibonacci retracement tools but 50% is not a Fibonacci level – the 50% level comes from Dow Theory).

With the Andrews pitchfork drawn and the Fibonacci retracement levels identified we can look for confluences of support.

 

In the chart we can see that the first “bottom” occurred at the 50% retracement level of the May-to-September rally and the second “bottom” occurred at the 61.8% Fibonacci retracement level.

The third “bottom” formed just under the Fibonacci 78.6% level.

After two weeks of sideways consolidation price popped back over the 78.6% level and started trending slowly higher.

At this point the risk of trying to pick bottoms should be obvious.

Although price found support and consolidated within the confluence zones that our predictive tools identified, the support didn’t hold and price ultimately headed lower.

Elliott wave principle – 3 Waves and 5 Waves

Elliott wave principle (EW) provides some useful guidelines that we can use for Swing trading.

Based on EW theory price tends to move in patterns of 3-waves and 5-waves.

Five-wave movements generally occur in the direction of the primary trend, while three-wave moves are typically counter-trend.

Without diving into the minutia of EW we can use these simple guidelines to make a subjective judgment about whether a price movement looks complete.

Notice in the chart above that we have three distinctive downward movements followed by price bouncing or consolidating sideways.

The three impulsive downward waves and the intervening consolidations could form a five-wave structure suggesting that the downward price movement is complete.

Always remember however that the application of EW is subjective.

Another Technical analyst might look at this chart and identify a 7-wave structure as shown below.

 

We don’t want to get hung-up on differences in opinion about a technique that is highly subjective to begin with.

As Traders we can simply count the waves as they occur and understand that the probability of a price reversal increases as the wave count climbs.

The big picture and correlated Financial markets

When we are Swing trading it is important to pay attention to the markets that affect our trading vehicle of choice.

In this example we are trading an individual precious metals mining stock so the markets of interest are the mining Stock market indexes, mining stock ETFs, and of course the Precious metals themselves, Silver and Gold.

As part of our example Swing trade we would look at a number of other charts and vehicles before making any judgement call on whether price had reached a tradeable bottom.

At the time these charts were created, the precious metals and the mining stock sector were consolidating at a high level after a substantial rally in the May-to-September time frame.

Although individual stocks appeared to be completing their corrections the sector as a whole still appeared to have more downside coming.

This sector-wide assessment would have helped us avoid any losses that might have occurred by re-entering a bullish trade too early.

Traditional Technical analysis

In our Swing trading example so far, we have seen two failed opportunities to pick a bottom and enter a bullish Swing trade and now we have a third opportunity.

Traders who bought either of the first two “bottoms” got stopped-out with a loss and we don’t want to repeat their mistake.

Clearly the Andrews pitchfork and Fibonacci retracement tools are identifying important Support and resistance levels but they aren’t showing us when price wants to reverse direction and turn higher.

Let’s take a look at some of the mainstream Technical analysis tools and see if they can help us in this Swing trading example.

 

Moving averages: the 50-day Moving average (DMA) is above the 200-DMA and the 200-DMA is rising – both factors are bullish

Volume: a high-Volume spike into the third low could indicate a capitulation – the relatively flat Volume since the third bottom is appropriate for a price consolidation

Accumulation/distribution index: investors have stopped accumulating (buying) and been distributing (selling) this stock since it peaked in August – distribution may have ended since the indicator is moving sideways

MACD: both the signal line and the moving average are below the zero line which is bearish – on the positive side we have a MACD buy signal occurring as the signal line moves above the moving average

If these indicators were our only tools for making Swing trading decisions, what would we be thinking at this point?

Bullish assessment:

• 50-DMA is above the 200-DMA and the 200-DMA is rising
• A capitulation price low has occurred on high-volume followed by a sideways price consolidation
• MACD has issued a buy signal
• Price is oversold relative to both the 200 and 50-DMAs
• Investors have stopped distributing (selling) the stock

Bearish assessment:

• Price has fallen below both the 50 and 200-DMAs
• 50-DMA is pointing down
• MACD is in bearish mode (both signal line and moving average below zero line)
• Last day of chart shows relatively high selling volume

Let’s take a moment here and acknowledge that ALL indicators are lagging, which means they can only report on what has happened in the past.

While indicators provide valuable information for Swing trading, we need to keep in mind the differences between lagging indicators, predictive Technical analysis tools, and actual price behavior.

Swing trading rules – Entry points and Exit points

How do we decide when it is appropriate to enter a Swing trade?

One of the things we need to keep in mind is the differences between lagging indicators, predictive Technical analysis tools, and actual price behavior.

There are two fundamental styles of trading: rules-based and “flying by the seat of the pants”.

Novices tend to be “seat of the pants” Traders either through lack of knowledge, naivete, or bravado.

On average, these newbie Traders last about nine months and lose $10,000 before moving on to something else.

Some of the beginners learn valuable lessons from their $10K loss and ultimately learn to Swing trade profitably – most don’t.

It is possible to make money trading by the seat of the pants (i.e., trade on instinct, gut-feelings, tea leaves, etc.), but very few people succeed long-term without some sort of Trading rules to follow.

Some experienced Swing traders may tell you that they trade strictly on gut-instinct without realizing that they have actually internalized their Trading rules over a period of multiple years.

Their Trading rules have become embedded in their subconscious minds so it FEELS like they are trading with their instincts.

The point I hope I am making is that a Swing trader needs to have rules to follow for entry, exit, and position management.

Without rules to trade by, a beginner should take their $10K and put it back in the bank, not their brokerage account.

In this (relatively) short article, it isn’t possible to delve into specific Trading rules but we will be able to see where Trading rules come into play and why they are important.

Let’s return to our Swing trading example now…

Swing trading example continues

In the chart above it certainly appears that a price Breakout has occurred to the upside.

Do we go long at this point? Have we already missed the trade? Is this a bull trap?

Trading rules are the answer to all of these questions.

When we clearly define how we will Swing trade, these questions become irrelevant.

We simply follow our rules knowing that they will maximize our profits and minimize our losses in the long run.

Breakout traders might be buying this stock at this point in the example (chart above) because the price action has met their criteria for entry (entry rule: price must break above a trading range by X%).

 

More conservative Swing traders might wait for price to pullback to the Breakout level before taking a position in the stock (entry rule: price must Breakout by X% and then return to test the Breakout level).

In this example conservative Traders would have gotten their entry orders filled, but in a strong bull move price might not pullback all the way to the Breakout point. Gun-shy Traders could be left on the sidelines watching price soar higher.

A key point to keep in mind: there are an infinite number of Swing trades to be made as long as a Trader stays in the game – missing out on any single trade is not going to break the Trader’s career.

Fractal nature of Financial markets

Financial markets are fractal in nature which means that the same patterns occur at all time frames.

It doesn’t matter whether we are Day trading with tick charts, Position trading with weekly charts, or Swing trading with daily charts, the Technical analysis methods and tools being covered here are equally valid.

Let me caveat that statement by emphasizing that the predictive Technical analysis tools are only valid when applied to significant Pivot points.

Identifying valid Pivot points becomes more challenging and error-prone as we go to smaller time scales (e.g., 233 ticks, 3 minutes, 5 minutes, etc. in comparison to daily and weekly).

The reason I am mentioning fractals at this point is because our example Swing trade is turning into a Position trade as price continues to waffle mostly sideways.

At the start of this missive we defined a Swing trade as being 2 days to several weeks in duration.

Our example trade has devolved into a sideways consolidation while the physical Gold market does the same.

This kind of price behavior is one of the scenarios where a time-based exit rule could come into play.

A Swing trader could exit this trade at the end of the third week and gain about 40 cents per share. That kind of small profit is certainly not what we are aiming for but it lets us walk away from the trade whole and preserve our capital for the next trade.

Because of the fractal nature of Financial markets we will continue with our example trade since it is demonstrating the key principals that we want to apply in our Swing trading.

Let’s fast-forward a few weeks in our example and see how this Swing (Position) trade is going…

 

Price is revisiting the Breakout level at this point only this time the indicators are looking fairly bearish.

• Price has broken below the 50-DMA and returned to test the Breakout level again
• Price has broken below the median line extension (ML2 in chart above) of the modified-Schiff pitchfork
• The 50-DMA has moved below the 200-DMA
• The 50-DMA is still pointing downwards although not as steeply as it was before
• Selling Volume has surged and we can see that distribution of the stock has resumed
• MACD has rolled-over and remains in bear mode (both signal and moving average below zero)

Regardless of how a Swing trader entered the stock in this example, the trade appears to be in trouble.

At this point the “seat of the pants” trader may be second-guessing the trade and considering a quick exit.

The rules-based Swing trader, on the other hand, will stay in this trade until one of her exit rules is triggered. She can relax in the knowledge that her Trading rules will lead her to profit in the long-term, regardless of how this single trade turns out.

So the rules-based Trader will continue with this example trade and check out what happens the very next day…

 

Price has surged back above the 50-DMA on high Volume and closed at the highest price of the day (closing on the high is bullish price action).

Fast-forward a few more trading days and the price action is looking even better.

 

Our trade is looking pretty good now.

Price has broken above another resistance level and retested the Breakout level successfully.

The Breakout and retest demonstrate that the resistance level has turned into a support level and we can see in the chart that this same level provided support in the past.

This is a good point to talk about position management and protecting profits.

If we haven’t moved our stop-loss order up by now, we certainly could.

The 200-DMA should provide strong support so we might move our stop so it is just under the 200 day-Moving-average.

This locks in some profit on this trade regardless of what happens going forward.

Time-based Exit points

As mentioned above, our Swing trade hasn’t evolved quite the way we were expecting.

Instead of working its way steadily higher in a timely manner, price is waffling mostly sideways.

At some point we may want to bail on this trade because we are putting our precious capital at risk and the trade isn’t doing what we expect (or isn't doing it as quickly as we would like).

Instead of hanging-out in this trade we may want to move our capital to a vehicle that is ready to move now.

A time-based Exit point is another Trading rule that every Trader should have defined in their Swing trading plan.

With our Trading rules defined (and written down!) ahead of time there is no uncertainty about what to do in our example trade.

As Swing traders we could choose three weeks as our time-based exit.

It is critical that we follow our Trading rules consistently. If three weeks turns out to be a non-optimum length of time for a "cut bait and run" exit, we can tune and tweak our rules to improve our profitability.

If we exit one trade at three weeks and another at two weeks and another trade somewhere in the middle, there is absolutely no way to tune the time-based exit rule. This truism applies to all Trading rules.

Fibonacci extension and Target prices

When we are in a successful Swing trade we want to have some idea of where we will exit and take profits.

The Fibonacci extension tool allows us to identify specific levels where a price movement is likely to run out of energy and either consolidate or reverse direction.

We apply this predictive Technical analysis tool using three price points as shown in the chart below.

We can use price levels identified by the Fibonacci extension tool for two purposes:

1. Exiting with a profit

2. Judging the strength of a price movement

Price commonly reaches at least the 0.382 (38.2%) extension level of a significant price movement so we might choose to take at least partial profits on our Swing trade when price reaches that level.

If price is making a really bullish move we might decide to hold at least some of our position with the 1.618 (161.8%) extension level as a Target price for taking profit.

As an example of determining strength, notice in the chart below how price gapped higher and then sliced right through the 0.236 (23.6%) Fibonacci extension level which had stopped it before. This is a sign of strength.

 

Elliott wave principle

 

Elliott wave principle provides us with another method of predicting when a price movement will run out of energy.

There are Fibonacci relationships between the five legs of an upward price movement and we can apply these relationships as soon as we have three Pivot points.

In the case of our example Swing trade, the first four waves of the five-wave movement are complete, so we can apply these high-level guidelines from Elliott wave principle:

When Wave 3 exceeds 1.618 times the size (in terms of price change) of Wave 1, then the size of Wave 5 is likely to be one of these three values:

  • equal to Wave 1
  • 618 times Wave 1
  • 618 times Wave 1

When the size of Wave 3 is less than 1.618 times the size of Wave 1, then the size of Wave 5 will likely be one of these values:

  • 618 times the price change between the start of Wave 1 and the end of Wave 3 (points 0 and 3 in our example trade)
  • 618 times the price change between the start of Wave 1 and the end of Wave 3

 

Point Price
0 3.09
1 5.50
2 4.17
3 7.78
4 4.98

 

 

 

Wave Size 1.618 x Wave Size 2.618 x Wave Size
1 (point 0 to point 1) 2.41 3.89 6.30
3 (point 2 to point 3) 3.61 5.84 9.45
1-to-3 (point 0 to point 3) 4.69 7.58 12.27

 

 

In our example Swing trade, the size of Wave 3 ($3.61) is less than 1.618 times the size of Wave 1 ($3.89) so we will apply the second of the guidelines above which gives us $7.58 and $12.27 as the likely values for the size of Wave 5.

When we add those values to Pivot point 4 in our chart (the assumed start of Wave 5) we find that price in Wave 5 could be targeting either $12.56 or $17.25.

We can factor these price targets into our integrated analysis for the example Swing trade. Obviously $12.56 and $17.25 are candidates for profit-taking exit levels.

Putting it all together - Swing trading strategy

We have covered a lot of ground in this article.

We've seen how the predictive Technical analysis drawing tools Andrews Pitchforks, Fibonacci retracements, Fibonacci extensions, and Elliott waves can be used to identify potential Swing points where price will run out of energy and reverse direction (price highs and lows).

We looked at some of the traditional Technical analysis tools like Moving averages, MACD, and the Accumulation/distribution index.

We saw how Volume can be used to confirm chart patterns like capitulation selloffs and Breakouts.

As we worked through our example Swing trade we highlighted a few trade entry and exit rules that can be used as part of an integrated Trading strategy and plan.

At Satori Traders we have developed an integrated methodology for combining the results of our Technical analysis to profitably Swing trade the Precious metals mining stocks.

If you are interested in developing your skills as a Swing trader, it is hard to beat learning by example.

Satori Traders regularly publishes Swing trade setups in the weekly newsletter and in our articles.

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