Swing Trading – Following The Trend

Price action almost always moves up or down, rarely in a straight line. What we see on a price chart are a series of waves moving up and then down. As each wave is usually of a different length in time and price from another wave, the overall result will usually be a market moving up or moving down, for which we label as a BULL or BEAR trend, respectively.

In a BULL trend, we normally expect to see the waves that are moving up being longer in range and/or time than those waves moving down. In a BEAR trend, the waves moving down are usually longer in range and/or time than those moving up. Those longer waves that are in the direction of the trend are called IMPULSE waves, and those shorter waves that are counter to the trend are called RETRACEMENT or CORRECTIVE waves.

A ‘Swing Trader’ is someone who normally holds a trade longer than a Day Trader but not as long as an Investor. A ‘Swing Trader’ is also known as a ‘Position Trader’. Trades made by ‘Swing Traders’ are usually from 2-3 days to perhaps a week or two at most.

Because IMPULSE waves, those that are in the direction of the prevailing trend, are usually longer in time and/or larger in price range, these are the waves that the ‘Swing Trader’ looks to trade as opposed to the shorter CORRECTIVE/RETRACEMENT waves.

The ‘Swing Trader’ therefore looks first to determine the TREND. Once this has been determined, the ‘Swing Trader’ will look to enter at what may appear to be the end of a CORRECTIVE/RETRACEMENT wave.

The term ‘SWING’ refers to the point in time and price where one wave ends and a new wave in the opposite direction begins. Thus, the beginning of an IMPULSE WAVE (end of CORRECTIVE WAVE) and the beginning of a CORRECTIVE WAVE (end of IMPULSE WAVE) are considered ‘SWINGS’.

Timing when these ‘swings’ are likely to occur is extremely important to the SWING TRADER, for the purpose of entry and exit. But before that is done, the TREND needs to be determined.

Several approaches are available to help determine the likely trend. Many chartists employ the use of moving averages to help determine the trend. One popular approach is to plot a 50-day and 200-day moving average line onto the chart. If prices are trading above the 50-day moving average, the short-term trend may be considered ‘bullish’. If prices are trading below the 50-day moving average, the short-term trend may be considered ‘bearish’. The 200-day moving average may be considered a more ‘longer-term’ trend indicator, used the same way as the shorter-term 50-day moving averages. Additionally, some may also require the 50-day moving average to be above the 200-day moving average before considering the market bullish, and bearish if the 50-day is below the 200-day. For SWING TRADERS, it is enough to just use the 50-day moving average in order to trade the short-term time frame of a few days to a couple weeks or so.

Other approaches to trend consideration is to look first at the higher time frame than the one used for trade entry. For example, the SWING TRADER will usually trade from the DAILY price chart. Therefore, the WEEKLY time frame chart can be used to determine the short-term trend. One approach is to look for whether the weekly chart is forming IMPULSE WAVES moving up or down. If the weekly chart is making higher SWING TOPS and higher SWING BOTTOMS, the IMPULSE WAVES are the upward waves. This would be considered bullish and therefore the SWING TRADER will look for the end of CORRECTIVE waves (bottoms) on the daily chart to enter long. If on the weekly chart the IMPULSE WAVES are moving down, where you see lower SWING TOPS and lower SWING BOTTOMS, then the outlook is bearish and the trader looks for the end CORRECTIVE waves (tops) on the daily chart to enter short.

However the SWING TRADER decides to determine the trend, it sets the tone for what type of SWINGS to look for to trade.

One of the most common approaches to anticipating the end of CORRECTIVE/RETRACEMENT waves for trade entry is to look for SUPPORT/RESISTANCE levels. Because the CORRECTIVE wave is expected not to be as much in price as the preceding IMPULSE wave, SUPPORT/RESISTANCE is often calculated by dividing the preceding IMPULSE wave by some ratio value. Common values often used are 38%, 50% and 62%. Sometimes a CORRECTIVE wave may even reach 75% before starting a new IMPULSE wave in the direction of the trend, although 38, 50 and 62 are more common.

SUPPORT/RESISTANCE may also be determined by noting how previous prices have reacted to certain price levels. While prices are making IMPULSE and CORRECTIVE waves, overall price is either moving higher or lower (trend). SUPPORT/RESISTANCE levels in such cases tend not to be static but sloping in the direction of the trend. The use of TREND LINES are often used, either below a series of higher SWING BOTTOMS for a bullish trend, or above a series of lower SWING TOPS for a bearish trend, as a rough estimate of SUPPORT/RESISTANCE for future price moves that return to that line.

SWING TRADERS will often look for the CORRECTIVE wave to return to a SUPPORT/RESISTANCE level and look for some indication that prices may be respecting that level to initiate a trade. Once in the trade, the SWING TRADER will often look to stay in that trade with the expectation that prices will continue to move beyond the end of the last IMPULSE wave.

For example, suppose the trend has been determined to be bullish. When an IMPULSE wave ends and a new CORRECTIVE wave begins (call this point A), price then is moving against the trend and retracing a percentage of the gains made by the recent IMPULSE wave. At some point along this RETRACEMENT, say 50% or perhaps it reaches the upward trend line place below several previous swing bottoms, price starts to move up again and the trader enters long. The trade is then managed with the expectation that price will continue to move higher, overall, and reach and exceed the top of the last IMPULSE wave (point A).

Some SWING TRADERS also include TIME as part of the signal to enter a trade. We have discussed PATTERN (TREND and WAVE) and SUPPORT/RESISTANCE, which are the two basics for any SWING TRADER. Using TIME adds a new and powerful dimension to PATTERN and PRICE, but is outside the scope of this article. It is to the advantage of the serious SWING TRADER to also consider incorporating TIME into the trading decision process, as this helps minimize false entries and also provides advanced indication that the end of a CORRECTIVE wave is imminent to within a day or two.