Basic Concepts
Swing Trading refers to buying a stock and holding that position for several days to a several week period in order to capture short term gains by taking advantage of the cyclical nature of stock price movement.
Typically we look to enter a swing trade in a stock that’s in a primary uptrend. We wait for a pullback or dip and then look for signs the uptrend is resuming.
Waiting for signs of a trend resumption prevents entering the trade prematurely.
We could use any number of technical signals that the uptrend is resuming such as a short-term moving average or a pivot low. The key is to avoid buying on the way down – even though we are looking to enter on a pullback.
The Basic Elements of a Swing Trade
A Swing Trade Is Composed Of 6 Basic Elements
The Anatomy Of A Swing Trade
1.) Trade Trigger and Entry Zone
The trade trigger price is where we have identified the trend resumption and are looking to enter. In other words, after the dip or pullback has run its course, the stock will show signs of strength again and we can use various technical indicators and the chart pattern itself to identify a good Trigger Price or entry zone.
2.) Initial Protective Stop Loss
When a stock is triggered into a trade we always want to place an initial stop-loss. This is a hard GTC (Good Till Canceled) stop loss that protects against catastrophic loss by a failed trade and a runaway price move to the downside. Think of this as your main non-negotiable line of defense for each trade.
3.) Trailing Stop
When a stock begins to move in our favor past the trigger price – we want to ratchet up our initial stop and turn it into a trailing stop. The trailing stop is designed to keep us in a trade during the swing cycle and at the same time designed to tighten under an upward moving price over time to lock in and protect gains that are achieved.
4.) Delta Target
For each stock that triggers an entry we want to set what we call a Delta Target. Think of this as a high probability 1st target where you have the option to take half or all of your position off the table. A good Target should be based on the ATR (Average True Range) of the stock. Somewhere in the area of 3.5 times the stocks average daily range is a reasonable first target.
5.) Trend Runner
When a stock hits the first Target and continues to move to the upside it becomes a Trend Runner. A stock can continue as a Trend Runner as long as it moves higher and does not hit the trailing stop. Many trend runners can achieve gains 3-4 greater than the system Delta Target during the course of an extended swing trade.
6.) Parabolic Stop
As a stock price really takes off in your favor you will often see price momentum and trajectory accelerate quickly to extremely overbought and unsustainable short term levels. When this happens we want to employ what we call a Parabolic Stop. A trader can use the parabolic stop to squeeze out final profits after a good run or use it as a protection level on a portion of the trade holding the remainder with the normal trailing stop.
Variations On The Swing Trading Theme
The basic concept of swing trading is to buy low and sell high within the context of the short term price cycle which is typically 2-3 weeks in duration. Typically the strongest and smoothest stocks within a confirmed uptrend are the best stocks to consider for swing trades so that the price continuation and upside potential is maximized in your favor.
We want to locate these just as the stock is nearing a potential “buy low” zone in the current swing cycle above that stocks strong upward momentum. At this point we want to determine our trigger price. Remember, we want to buy into strength after a pullback, so the trigger price is generally over a recent high at a level that provides a good risk-reward ratio based on where the initial stop is placed.
Stocks in longer-term primary uptrends are the best swing trading candidates.
It almost goes without saying, but the best stocks to put on your radar for potential swing trades are stocks in uptrends. There are tons of ways to determine whether a stock is in a primary uptrend but we won’t get into that here.
The more orderly the chart the better. The smoother the price action in the stock is – the better chance we will have in identifying a buyable dip.