Season Of The Swing
Alan S. Farley is a new weekly contributor to TradingMarkets.com. Watch for his
swing-trading insights every Thursday at 4:20 ET.
Can you feel the winds of change?
The market world is changing quickly for the retail trader. Yet few see the
vast impact on strategies, position choices and broker accounts. Three major
forces are converging to dramatically alter the short-term trading landscape. In
fact, your long-term success in market speculation requires that you adapt
quickly to this challenging new environment. Fortunately, there is still time to
act. We are right in the middle of this revolution, and you can still apply
dependable tactics if you adjust quickly to the new game.
1. Life After The Bear
First, let’s consider where we’ve come from. Throughout the 1990s, the upside
momentum trader ruled the roost. Whether buying the dip or buying high and
selling higher, simple strategies promised a comfortable road to quick fortunes.
The secular bull brought thousands of new faces into the trading game and
spawned a giant industry of high-speed technologies, software interfaces and
market gurus. Even waitresses and shoeshine boys got caught in this wave of
public excitement and tossed their precious savings into e-broker accounts so
they could grab their share of this great giveaway.
We all know what happened next. Fortunes were lost and careers were ended
when the market played directly to the weak hands of the majority: lack of
defensive risk management and profit protection. As the selloff continued,
participants fell into an expensive trap and tried to play the broad decline by
applying the same tactics that worked so well on the trip up. Unfortunately, the
trading gods never give up their gifts so easily. Common knowledge of a broad
market condition eventually closes the system inefficiency that allows easy
profit. Sometimes the market can adapt quickly and shut off profitable
strategies in a matter of days. But in our latest example, it took an entire
bull run of almost a decade before it crushed the faithful.
The first reaction by many traders aware of the changing conditions was to
shift from the upside momentum game to selling short in the massive selloff.
This appeared to be a logical move, but carried one fatal flaw: it required
careful application of the same risk-management techniques that defeated so many
participants in the first place. Short squeezes erupted without warning and took
out many traders who had survived the initial violent turn in March 2000. More
and more downside momentum players entered the game as the decline evolved.
Squeezes became less dangerous and many short-term traders started to feel like
market wizards all over again.
Which brings us to the current trading environment.
The financial markets may or may not be in the process of forming a long-term
bottom. But one thing is for certain: successful trading in the next few years
will be far more different than during the go-go times of the 1990s. For
example, those who believe we will see a V-type bottom with the indices charging
back to old highs are in mortal danger. Upside momentum in the early days of
this new millennium will be an elusive trading partner. So if you haven’t made a
tactical and mental shift already, start immediately to trade the many stages of
the short-term market swing. This classic strategy will become your best friend
as you work to rebuild your account in order to capitalize on the next broad
market trend.
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| Amgen spends five months going nowhere. But the sideways action hides 18 distinct price thrusts that translate into swing-trading profits. Note how the multicolored MACD Bands expose a natural market “wobble” that often turns price right at expected reversal levels. |
How does swing trading differ from momentum trading? In the narrowest
definition, swing traders respond to the world of price boundaries. They expect
support and resistance to hold when price contacts these important levels.
Alternatively, momentum traders respond to the world of price breakouts and
breakdowns. They expect support and resistance to fail when price contacts these
same levels. But an even more powerful view of swing trading should be applied
to our brave new world.
Swing trading provides a natural framework to identify changing conditions
and apply new methods to exploit them. Use its classic tactics to buy weakness
and sell strength when choppy markets shift back and forth to test common
boundaries. But realize that swing trading is not really the opposite of
momentum trading. During those times when directional movement characterizes a
market, disciplined momentum strategy becomes the preferred swing trade. In this
way, modern swing traders can apply the principles of risk management and price
boundaries to the manic world of the speculator.
2. Dirty Decimals
The retail trading industry in the 1990s was fueled by new software that
allowed traders to exercise scalping strategies that had been the exclusive
domain of the institutional crowd. Members of this exclusive club saw the
promise of these new execution systems and opened dozens of direct-access
brokerages and alternative routing platforms. What happened next is now part of
market folklore.
The limitations of Level II scalping have been well documented over the last
year or two. Now that the dust is settling, most recognize that teaching this
frantic trading method to new market participants was a terrible mistake and
doomed most of them to failure. But many who survived the cleansing process were
able to make a decent living buying the bid and selling the ask. Meanwhile, the
rest of us stood aside and watched this dynamic process through heightened
market volatility and technical violations of known intraday support and
resistance levels.
Decimalization alters the playing field for these intense short-term tactics.
Evidence is quickly mounting that even good scalpers cannot duplicate the
financial results they enjoyed before the changeover. Linked trading tactics
also appear to be experiencing death by pennies. Many players make their livings
by fading scalpers through sharp stop-gunning exercises and short squeezes. But
like feet stuck in the mud, they are having great difficulty pushing price
through the endless penny tiers in order to shake out the opposition.
Once again, swing trading comes to the rescue. The revolution in high-speed
trade execution opens swing strategies that last for minutes instead of days.
Dependable price patterns appear on charts in all time frames. Retail scalpers
are quickly finding that intraday swing setups on one-minute and five-minute charts
offer the same opportunities that appear daily on longer-term charts. And the
swing revolution started by decimalization does not end there. Institutional
scalpers and market makers are quickly adapting their contrary tactics to this
chart-based trading style and abandoning the pure spread game.
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| Amgen trades within a single point during four hours of intraday action. But the one-minute price chart reveals predictable breakouts and reversal scalps throughout the session. Note how the price-expansion levels in the shaded areas can be captured by intraday swing traders but will probably be missed by the herd of Level II scalpers. |
3. Evil Pattern Daytraders
Pattern Daytrader does not refer to the scalper who uses a chart to make
buying and selling decisions. It denotes the “black mark” that your
broker-dealer must place on your account if you violate a new SEC rule, starting
this September. The PDT is anyone who completes four or more intraday round trips
in a consecutive five-day period. Once you are marked as a PDT, you must maintain
$25,000 or more in your trading account or it will be reverted from margin to
cash status.
This sounds simple enough at first glance. So simple that it was heavily
supported by the brokerage industry when the rule was first proposed in early
2000. At that time, there was an endless supply of new talent that the brokers
expected to open accounts for. They were also willing to do anything they could
to get the stigma of daytrading (and SEC audit trails) off of their backs. And
many direct-access brokers already had a $25K or more account requirement, so
they felt there was little to lose in going along with the proposal.
But that was then, and this is now. The trading industry has fallen on hard
times in the falling market. Account growth has stagnated or declined at many
firms. Many direct-access broker/dealers are becoming painfully aware how much
they depend upon small trading accounts at discount houses to train their future
clients. Many new retail traders use the lower risk of small discount accounts
to build their intraday execution skills (and profits) so they can someday
transfer to direct-access. But soon this core talent will be getting very
unfriendly mail telling them to change their methods, or place new funds into
their accounts. This will likely cut off the major source of direct-access
growth.
But the rules affect only daytraders, right? Wrong. Consider this: in
volatile markets, how often do you realize you’ve made a terrible mistake just
after entering a new position trade? Wise risk management tells you to get out
immediately in that situation. Now what happens if you run a bad streak and find
yourself doing this four times in one week? You’ve just become a Pattern Daytrader.
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| Position traders may become Pattern Daytraders when they make mistakes or exercise sound risk management. Each shaded zone invites ill-timed positions in the wrong direction. Common sense dictates that these positions should be abandoned as soon as possible, in order to limit losses. But doing so invites major trouble with your broker if you are trading a small account. |
Statistics on trading accounts point out that we are a nation of small
players. The percentage of us who consistently set aside $25,000 or more for
market speculation is quite small. So expect this new rule to greatly diminish
the role of daytrading in modern market life. What does this mean to you? Two
possible consequences come to mind. First, intraday liquidity and volatility may
diminish significantly as this rule couples with decimalization to cool the
short-term trading environment. Second, swing-trading tactics will grow
exponentially within this small-account universe because these traders will
realize it’s their only alternative for learning the market game.
Brave New World
Paradoxically, technical analysis will likely become a more dependable tool
because of these significant changes. Pattern failure and violations of classic
TA principles have become the norm since the trading masses discovered price
charts in the late 1990s. Its great popularity attracted a core of contrary
tactics designed to defeat these novice chart readers. As the current market
shakeout continues, less warm bodies will be trying to gauge every triangle or
double bottom formation for a trade setup. This is extremely good for serious
practitioners of technical trading.
We can be certain of only one thing: the financial markets will undergo
continuous change throughout our trading careers. That’s one of the greatest
challenges for modern speculators. We come into the game being taught that one
or two dependable strategies will serve us well over the long haul.
Unfortunately, the market always knows that we’re here, and what we’re trying to
do. It adjusts to defeat the majority at every turn. So we must do our best to
see changes early, adjust quickly, and jump onto the money train before the herd
charges in our direction.
Alan Farley is a
professional trader and the publisher of the Hard Right Edge https://www.hardrightedge.com web site, a comprehensive online resource for
traders. He is the author of the best-selling McGraw-Hill release, The Master
Swing Trader. Alan has been part of the market scene for over 14 years as a
private investor, advisor and author. In addition to trading, writing and
speaking, Alan has been featured in Barron’s, Smart Money, Tech Week,
MoneyCentral, Bridge Trader, Technical Investor and TheStreet.com. He has
consulted with the major news services on issues facing today’s online traders
and is a strong voice for the Net revolution changing the face of our modern
financial markets.
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