Getting Started In Momentum-Based Swing Trading

January 18, 2002
Dave Landry

The following was transcribed and edited from TraderTalk, a free, live, interactive workshop conducted for TradingMarkets
members by Dave Landry on Jan. 16, 2002.

I would like start with a brief
definition and then I’ll be happy to answer any
questions. Swing trading is simply short-term
trading, where positions
are held for two to seven days — longer when the market cooperates, shorter when it doesn’t.
“Momentum” is the key word. It is not about
fading the market — the trend is your friend.Â

Why swing trade?Â

As Mark Boucher said, “70% of a market’s moves occurs in 20% of the
time.” The idea
is to be in the market for that 20%, and out the rest of time. Momentum-based swing trading
is not about picking tops/bottoms! Trends last
longer than most are willing to believe.

Who should swing trade?

I think everyone should. Daytraders
can gain an edge by placing a bigger-picture pattern ( say, one good for two to
seven days)
behind them, so they can improve their odds.Â

Risk
can be defined, and you know fairly soon whether you are right or not. Longer-term traders can “trade around”
positions, e.g.,
say you are long 1,000 shares, you might add to your position when a setup
occurs and take off some when profits present themselves. I
know of some longer-term traders who beat their colleagues with this strategy.

Look at the [ INSP|INSP] chart below. Notice the trend went a long
ways but eventually ended — and a new (tradable) downtrend emerged.

How
do you identify momentum?

There are computerized methods like ADX and RS — these help when scanning, but I mostly like to
eyeball charts.Â

Trends
leave behind “clues.” I have dubbed these clues “Trend
Qualifiers.” Notice in the chart that the stock started with a
base breakout, hit new highs, had strong closes, wide-range bars, gaps, etc. Notice how the stock “acts” after each
pullback, it resumes its trend.

Another way to determine trend is to use moving averages, I like
a 10-day SMA, 20-day EMA and 30-day EMA.Â

I
look for the slope of the moving average to
be up for uptrends, and for the averages to be in “Proper”

order — faster above slower (i.e., 10 > 20 > 30) and for daylight.Â

Daylight is simply lows greater
than the
moving average for uptrends, i.e., there is “daylight” between the
low and the moving average. This is illustrated in
the following figure and graph.

Identifying trends is not rocket science. If you
can’t figure it out, it’s probably not a trend. And of course, my favorite
technique: Ask a six-year-old kid!

Trading with the trend does not mean blinding jumping on a trend.
I
like to wait for a pullback to occur. Refer to the
figure below: The pullback consists of a trend (a)
and a correction (b). You
enter if and only if the trend begins to re-assert itself (c).
You have to place a protective stop on ALL trades just in
case you are wrong…this normally goes below the low of the setup (d).

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PowerRating), mentioned recently in my column, is a good real-world example.

Money management is crucial
to any style of tradingÂ

As George Soros said, “In order
to make money, you must first not lose money.“

You must use protective
stops.

You must take partial
profits, usually when your risk = profits.

You must then trail your stops to hopefully capture a home run.

Finally, you must put together a game plan when trading

Ask yourself, “What
is the market doing?”
I have market timing systems I
follow: Look at
the 3-day average TRIN readings, the CHADTP, VIX systems, oscillator swing
system — and the charts themselves.Â

Next, you must be in the strongest sectors — and
the strongest, best setups in the stocks in that sector. Finally, you must be focused,
free of distraction, and ready
to trade.

And remember, PROTECTIVE STOPS ON EVERY TRADE!

Q&A

Q: Dave, do you day trade
at all using your concepts for swing trading?

A:Â
The concepts do apply. I know
those who watch bowties on five-minute S&Ps. I haven’t daytraded lately, but
do occasionally fire off a daytrade on an intraday pattern, e.g., pullback

Q: It seems
volatility is not increasing much?

A:
It’s choppy — too choppy! Persistency
is necessary. In markets like these, you just have to place smaller bets and
trade less.

Q: It seems that
with the market lately that intermediate time trading is pretty futile. Swing is
even getting to that point. What would you recommend for avoiding the pitfalls
of only trading with after-hours information?

A:Â
I’m assuming you are asking how to
improve trades during these tough times. Trade less and be very selective. If
you lose on a string of trades, back off and ease back in. Better times will
follow. Make sure you save your capital until then.

A: It shouldn’t take out the 1/14 low. If
it does, it may be in trouble.

Q: Do you ever
consider volatility, such as ATR, when sizing your position or setting your
initial stop?

Q: Is the TRIN
still as effective as it was?

A: I think so. My TRIN Reversal system
has had some great signals in the last year or so. Some say that decimalization
negates the TRIN, but I disagree. In fact, I love
it when people pooh pooh indicators. That’s when they start to work again.

Q: Should the time
frame of a “trend” be based on a security or can a generic timeframe be applied
to all securities?

A: I don’t think it should be generic. If
a stock makes a big move in a short period of time, I consider it a trend. New
issues (remember those?) are a good example of
short-term strong trends.

Q: Do you have any
systems/patterns that are not revealed in your book
that you could share with
us?

A: I could tell you, but then I would have
to kill you… Seriously, not really. Most of what I do is all spelled out. I do add a layer
of discretion,
but I talk about that on the website too. I am ALWAYS looking
for new patterns — although I haven’t found
anything lately. Another thing that you should be doing is studying money management
too.

Q: How do you find
sectors that are strong and using whose definitions of sectors? It seems that
TC200 has one set of sectors, while others have different sets of sectors with
more or fewer stocks in the sector.

A: I look at some of those in TC. I also
look to the HOLDRS, the optionable sectors (SOX, XBD, etc.) and individual
stocks. I like to look at as much as possible. I also look to subsectors,
especially when I find a hot stock in a poor overall sector. Looking
at lots of stocks each day helps me to find strength/weakness.

Q: Due to
the popularity of your book and
service, have your signals become less reliable?

A:Â
I think that the choppy market has
more to do with it than anything. People are people. They will always put their
twists on things. I don’t think I’m famous enough to change how people will
trade.

Q:Â
What is CHADTP and Oscillator swing system you mentioned
for market timing? Can you give more details about your three-day average TRIN
reading?Â

A:Â
CHADTP equals the five-day average advance
minus the five-day average decline. I don’t use it as a system, rather an
overbought/oversold indicator. My TRIN reversal
system uses the three-day average TRIN readings. When they hit an extreme and
reverse it, signals a signal. If you don’t have my book, e-mail me at
sentivetradingco@prodigy.net
and I’ll give you the exact rules. The Oscillator swing system looks for
overbought/oversold 3-10 osc, and then looks to go long/short on an intraday
reversal. Again, email me for the rules.

Q: At what point do
you start taking partial profits?

A: When profit is greater than initial
risk. See the money management articles on the site.

Q: In which cases
do you consider turning around, instead of only closing a position?

A: I assume you mean reversing a
position. I don’t do that in stocks. In the pastÂ have, on volatility plays in commodities,
done a stop and reversal. Due to the fact that I co-manage a fund as
a CTA, I have avoided trading commodities for a while — makes life easier with
the NFA.

Q: What about swing
trading by focusing on the
(
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PowerRating)s?

A: I think
Don
Miller does a fine job of
handling that. Read his stuff. He’s pretty good.

Q: How do you
determine if you’re going to go short or go long on swings? Take now, for
instance. Are you shorting swings or going long your swings or out on the
sidelines?

A: I try to put the market and sector
behind me. If I can’t tell the direction, then I back off. I’ve scaled back on
trading during these choppy times.

Q: Could you please
explain the volatility factor given in your subscription
service?

A: I use historical volatility to measure
it. It seems that most of the stocks I pick lately have a high HV, so they get
the highest ranking (1). I probably could tweak it a bit — as almost everything
turns out to be a “1.”Â I do point out when I think something is VERY volatile.

Q: For stock
selection, do you start with a scan from site? If so, can you share the scan
details?

A: I mostly look at charts…but do run
scans for my patterns.

Q:
In
this crazy market, it seems defining a predefined percentage gain (not too greedy of a
percentage)
can give better results than follow-up stop-losses, e.g., take an 8% profit
as soon as it hits. What are your thoughts?

A: Yes, it seems like the market tempts
you with a small profit and then takes it away. Lately, yes, that has been the
thing to do, bail out with a small profit. Keep in mind that as soon as this really works
(I got an e-mail from
someone who told me they are hitting 80%-90% doing this), then conditions will
change. Then, you might find yourself risking too much and taking too little
profits. When the market trends again, the REAL money in momentum trading will
be made by trailing stops. Nothing wrong with recognizing the environment and
adjusting to it, though!Â

Q: Based on your
approach and recent market action, you’re likely out of 90% of your long
positions. How will you know when to get back in?

A: You are correct. I’ll start looking to
nibble — and nibble only — in this oversold environment, waiting for triggers will
help here. Once I get some buy signals and see the market shaping up/holding
support, I might look to buy some more. If we break support and start getting
sell signals, then I’m back to the short side. Also, I like to watch the 50- and
200-day moving averages. NOTHING MAGIC ABOUT THEM, but they do give you a point of
reference.

Q: What’s the best
way to enter/exit a position if one works and cannot watch the market all day?

A: I like entry
stops: buy stops for
longs ABOVE the market and sell stops for shorts BELOW the market. As far as
taking profits, ideally you should be able to check in at least a few times a
day. For instance,
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PowerRating), a short from my
service, was creamed this morning and
stayed down for a while, but it did bounce. If you could have checked quotes,
you could have seen this and taken some profits. You could also use limit orders
at a profit target, but make sure you adjust your protective stop once filled.

Q: Is the best source of potential swing trades
on “Trading Markets’ Pullback
list”?

A: No, the best source is
my column and

swing trade service! LOL

Q: Hi, Dave.
This is my first chat. Is there anywhere I can see summaries of past chats?

A:
TraderTalk
is a new interactive forum on TradingMarkets.com — this is only the second in
the series so far. Larry Connors ran the first workshop last week (summarized in
his “Market
Timing Using the VIX).Â

I would like to sincerely thank you all for joining
me today.

Getting Started In Momentum-Based Swing Trading

BUY THE FEAR, SELL THE GREED

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