The Swing Trading System Enigma – And How to Profit From It

The swing trading system takes advantage of the human emotions bound up with trading the financial markets by identifying overbought and oversold positions. The traditional tools for doing this are charts, but I believe charts on their own are not enough to identify the stocks or other securities that are becoming potential trades. Something else is needed for that.

Before we work out what it is, we have to acknowledge that swing trading is based on different criteria from the “trend” method of trading, even though both cash in on the human factor. “The trend is your friend”, and traders following this method identify a definite up or down trend that is in place before they hitch their wagon to it.

The drawback to this is that so often by the time a trend is identified it is already finished, or nearly so. Even when the trader manages to ride the tail end of it he often loses out when the trend reverses and he closes his trade too late to save his profits. Swing traders seek to avoid that fate by identifying in advance when a particular stock is likely to become overbought or oversold.

It can be summarised like this. Take any stock. If something happens that makes it more desirable it increases in price. But usually it doesn’t simply move up smoothly to the new price level that it should now occupy. It “overshoots” and goes above what you might term the correct market price.

At some stage traders realise that it’s gone up too much, so it comes down, but, again, not to the correct level. It overshoots again and is now undervalued once more. So it starts to move up again. This up-and-down movement continues until either it stabilises at the new price level or something else happens to affect the market price and it overshoots up or down yet again.

It’s these “overshoots” that swing traders watch out for. When a stock is moving up fast towards the resistance level, or moving down fast towards support, it’s most likely (though not always) going to break through, temporarily, and then it’s only a matter of time before it comes back towards its proper level and then overshoots that as well. Those are the price movements that successful swing traders profit from.

So how do you identify stocks that are about to perform like this? By leaving your charts for a while and paying attention to what is happening in the real world. You can’t do this for every single stock, or even for every single sector, unless you have massive resources at your disposal. As an individual trader you have to specialise to a degree.

Choose your segment of the market so as to ensure a fair degree of volatility (though not too much). Get to know what is going on in that sector, what the seasonal patterns are, what the problems and challenges are. Keep abreast of the news relating to stocks in that sector. This is pure fundamental analysis, of course, and many technical analysts (and swing traders are often technical analysts) would frown on it.

Nevertheless, I believe using the two stock market trading systems together is a far better way to swing trade. Use your knowledge of your particular market sector to gauge which stocks are likely to be at or near an overbought or oversold position in the near future, and only then study your charts to identify the right times to enter and close your trades. This “fine tuning” of your swing trading system should increase your profit taking considerably.