Ten Tenets Of Swing Trading
Swing trading is a method of trading which seeks to capture
short-term gains in markets. It involves identifying markets that have the
potential to make an immediate move, entering those markets and using strict
money management to help protect against major losses and lock in profits.
Trades are normally held for one to five days. Below we will look at ten general guidelines,
by no means
are exhaustive, but should help to keep you out of 90% of the trouble spots when
swing trading.
1. Limit Losses
As soon as position is
initiated, you should have a protective stop right below the recent support (for
longs), or above recent resistance (for shorts). Swing
trading often produces many small gains with only an occasional home run. Therefore,
protective stops must be used on all trades. Getting careless on just one trade
can erase many winners.
2.
No Tickie, No Tradieyes”> re-assert itself. It
is not about fading the market by picking tops and bottoms. Therefore, wait
for follow through before attempting to enter a trade.
For instance, suppose a market is in rally mode and begins to sell off,
chances are the next move will be a resumption of the original uptrend. However,
until that uptrend begins to resume, positions should not be initiated.
For longs, this means
waiting for the market to turn back up, and for shorts, it means waiting for the
market to turn back down.
3. Take Partial Profits Quickly
On most
swing trades, the profits will be small and have the potential to quickly erode.
Therefore, as soon as your profits (a) are equal to or greater than your initial
risk (b), you should lock in half of your profits and move your protective stop on your remaining shares to breakeven
(c) — (near your original entry).
Locking in half of your profits and moving your stop to
breakeven when your profits are greater than or equal to your initial risk,* will help to generate income for your
account. This income will help
to pay for the inevitable small losses associated with swing trading. Further,
barring overnight gaps, this gives you, at worst, a breakeven trade and a chance at a home run on the
remaining position.
4. Take Windfall
Profits
As a
swing trader, windfall profits are often few and far between. Therefore, you
should lock in all or a significant piece of your profits when parabolic moves
occur. After all, large moves occur as players dog pile onto a market as it
becomes obvious to the masses. You’ve got to ask yourself, once it’s obvious, and
the last players are entering the market, who’s left to buy?
As an example, notice below that Agilent Technologies
(
A |
Quote |
Chart |
News |
PowerRating) had a tremendous one-day gain (a), but all of those gains were eroded over the next
few days (b)
5. Trade In Liquid And Active Markets
As swing traders, we are looking for an immediate short-term move. We don’t have the luxury of waiting around
until a large price-move takes place.6.
Stack The Odds In Your Favor
In trading,
the more pieces of the puzzle that fit together, the better. Although in swing
trading, we are looking for short-term setups, it helps to have longer-term
factors in place. This can be in the form of momentum or big-picture technical
patterns such as cups and handles, head-and-shoulders bottoms (or tops), double
bottoms (or tops) and so on and so forth. These can be on daily, weekly or even
monthly charts. Some of the best swing traders find markets that have the
potential double or triple (over time) and look for short-term setups to capture
a piece of that move. Also, for stock traders, the above should be combined with
an overall market bias.
7. Enter The Entire Position At
Once
In swing
trading, we are in the market for a short period of time and looking for a swift move. Unlike the longer-term
player who has the luxury of building positions over time and at an average
price while waiting for the market to move, the swing trader is looking for an immediate move. In most cases, you
should be looking to lock in profits and tighten stops as the market moves in
your favor — not add to positions.
If you must pyramid, then do it quickly as the position moves
in your favor, and make sure it looks like an actual pyramid. In other words,
only add to profitable positions and establish your largest position
first. A 3-2-1 is good ratio for establishing positions. For
instance, if your position size is 500 shares, then enter 300, then 200, then 100,
provided of course, the market is moving in your favor while adding to the
position.
8. Keep Position Size Within
Reason
Swing
trading is a game of probabilities. You win some, you lose some, and hopefully,
through a consistent approach, you make money overall. Swing trading
is not about trying to hit “home runs” by taking excessive risk on any one position. In fact, you should
never take a position large enough to have a material impact on your trading
account should — or more likely, when — a price shock occur.
9.
Remain Consistent
Successful traders find
a formula and stick to it. Swing trading is no different. You must find an
approach that works for you and apply it in a consistent methodical
manner. In addition to being consistent in your approach, you must also be
consistent in your money-management techniques. This involves keeping
position size within reason, using initial protective stops, taking profits and
trailing stops.
10. When In Doubt, Get
Out
In swing trading, we
are looking for an immediate short-term move. If the market doesn’t move
immediately, then there’s no need to remain in the market — even if you’re not stopped out.
The longer you are in a market that is not moving in your favor, the more you
are exposing yourself to a potential adverse move. In most
cases, you’re better off exiting the position and waiting for the market to set
up again. A good rule-of-thumb here is to only take home profitable
positions.
References and Additional Reading
*Larry Connors in Connors On Advanced Trading has dubbed this “2-for-1”
Money Management.
Street Smarts by Larry Connors and Linda Raschke.
A great manual for the swing trader.
Connors On Advanced Trading by Larry Connors.
Contains a plethora of knowledge for the short term trader.
Four part series on Money
Management, Position
Management, by Dave Landry.
Trading
With The Cup and Handle Pattern, Trading
Pullbacks, An
Introduction To Retracements, Combining
Volatility With Structure by Dave Landry.