Dave Landry On Laying The Foundation For Successful Swing Trading, Part III

In Part 3 of this lesson, I'd like to answer some frequently asked questions I receive from readers:

Q&A

Q. When trading pullbacks, how do you know that this pullback won’t be the last?

A. You don’t. You have to keep playing the stock as if the trend will last forever. Hopefully, you won’t get triggered on a pullback that turns into a major reversal. Or, at worst, you’ll get stopped out with a modest loss. The good news is that markets often offer many opportunities before they eventually fail.

Q. You didn’t mention ADX as a determinate of trend. Do you still use ADX?

A. In my first book, I felt that I had to quantify trend for those new to trading or those who needed more of an objective type analysis. Inadvertently, I think too much emphasis was placed on the indicator. I don’t use ADX to quantify a trend for a potential setup. I “eyeball” a chart and look for Trend Qualifiers. I do use ADX for research purposes, especially when working on contra-trend market timing signals. However, on a day-to-day basis, I simply prefer looking at the charts.

Q. Do you use actual or mental stops?

A. If I am distracted or have many positions on, I will place an actual stop. If I can watch a screen and not be distracted, I will use mental stops. I will look to exit after my mental stop is hit. In other words, I will “trade out” of the position. In some cases, I end up risking slightly more than intended and in other cases the trend resumes I end up with a winner. Mental stops do require discipline though. I’m amazed at the number of people who ask me for advice on what to do with a position after they have losses of 5, 10 and even 15-points or more. For these people, they should place actual stops in the market. This makes controlling losses a passive decision and not an active one.

Q. Do you carry stops overnight (i.e. good till canceled orders)?

A. No, I allow the stock to open and then place my protective stop. This allows me to “trade out” of adverse moves. Again, this requires discipline. If you find yourself being a “deer in the headlights”, hoping for a stock to come back, then you’re much better off carrying the stop overnight.

Q. You mention that the low of the pullback is a target area for market makers. Can you elaborate?

A. Yes. The “textbook” place to put your initial protective stop is right below the low of the pullback. However, if this is fairly close to the entry, for instance, less than those parameters given in table XX, then there is a high likelihood that it could be hit.

Q. You mentioned that the initial protective stop should be varied depending on volatility of the stock but you didn’t define volatility.

A. It’s beyond the scope of this text to get into complex volatility measurements. The good news is, one of the best ways to gauge volatility is to simply “eyeball” the chart. A hot technology stock that moves several points a day is volatile. And, you’re kidding yourself if you think you will be able to trade that stock with a tight stop. Conversely, REITs or certain utility stocks that might only trade several points in a week are not. Therefore, on stocks like these, tighter stops can be used.

Q. You seem to imply that people use too tight of stops to capture swing moves. Are there cases where a tight stop can be used?

A. Yes, if everything is “in gear”—the market is rallying, and the sectors and most stocks in it are rallying, then a stock should trigger and not look back. In these cases, you could use a tighter-than-normal stop and be willing to re-enter or find a better candidate if stopped out. Also, there are patterns (e.g. Witch Hats, Gatekeepers, etc.) where you can look to enter intra-day on the first signs of a reversal and use a fairly tight stop. If you are right, there’s the potential to be right big. But if you are wrong, you only risking a small amount.

Q. Doesn’t “2 for 1” money management have a negative expectancy since you are really only getting “1 for 1” at your initial profit target?

A. If you got stopped out on every winning trade after you took the initial profit at breakeven, they yes, it would have a negative expectancy because you are risking twice as much as you are making. However, by trailing a stop higher on the remaining shares, you position yourself for a potential home run. And, one or two home runs will take care of a lot of losing trades. Also, as mentioned in this chapter, this is a basic money management system. Use it as a base to build upon. For instance, this system can be “beat” by using simple techniques like taking profits early in choppy markets and letting them ride in momentum markets.

Good luck with your trading,

Dave Landry