Getting Started In Momentum-Based Swing Trading

The following was transcribed and edited from TraderTalk, a free, live, interactive workshop conducted for TradingMarkets members by Dave Landry on Jan. 16, 2002.


I would like start with a brief definition and then I'll be happy to answer any questions. Swing trading is simply short-term trading, where positions are held for two to seven days -- longer when the market cooperates, shorter when it doesn't. "Momentum" is the key word. It is not about fading the market -- the trend is your friend. 

Why swing trade? 

As Mark Boucher said, "70% of a market's moves occurs in 20% of the time." The idea is to be in the market for that 20%, and out the rest of time. Momentum-based swing trading is not about picking tops/bottoms! Trends last longer than most are willing to believe.

Who should swing trade?

I think everyone should. Daytraders can gain an edge by placing a bigger-picture pattern ( say, one good for two to seven days) behind them, so they can improve their odds. 

Risk can be defined, and you know fairly soon whether you are right or not. Longer-term traders can "trade around" positions, e.g., say you are long 1,000 shares, you might add to your position when a setup occurs and take off some when profits present themselves. I know of some longer-term traders who beat their colleagues with this strategy.

Look at the (INSP | Quote | Chart | News | PowerRating) chart below. Notice the trend went a long ways but eventually ended -- and a new (tradable) downtrend emerged.

How do you identify momentum?

There are computerized methods like ADX and RS -- these help when scanning, but I mostly like to eyeball charts. 

Trends leave behind "clues." I have dubbed these clues "Trend Qualifiers." Notice in the chart that the stock started with a base breakout, hit new highs, had strong closes, wide-range bars, gaps, etc. Notice how the stock "acts" after each pullback, it resumes its trend.

Another way to determine trend is to use moving averages, I like a 10-day SMA, 20-day EMA and 30-day EMA. 

I look for the slope of the moving average to be up for uptrends, and for the averages to be in "Proper" order -- faster above slower (i.e., 10 > 20 > 30) and for daylight. 

Daylight is simply lows greater than the moving average for uptrends, i.e., there is "daylight" between the low and the moving average. This is illustrated in the following figure and graph.

Identifying trends is not rocket science. If you can't figure it out, it's probably not a trend. And of course, my favorite technique: Ask a six-year-old kid!

Trading with the trend does not mean blinding jumping on a trend. I like to wait for a pullback to occur. Refer to the figure below: The pullback consists of a trend (a) and a correction (b). You enter if and only if the trend begins to re-assert itself (c). You have to place a protective stop on ALL trades just in case you are wrong...this normally goes below the low of the setup (d).

(MENT | Quote | Chart | News | PowerRating), mentioned recently in my column, is a good real-world example.

Money management is crucial to any style of trading 

As George Soros said, "In order to make money, you must first not lose money."

1. You must use protective stops.
2. You must take partial profits, usually when your risk = profits.
3. You must then trail your stops to hopefully capture a home run.
4. Finally, you must put together a game plan when trading

Ask yourself, "What is the market doing?" I have market timing systems I follow: Look at the 3-day average TRIN readings, the CHADTP, VIX systems, oscillator swing system -- and the charts themselves. 

Next, you must be in the strongest sectors -- and the strongest, best setups in the stocks in that sector. Finally, you must be focused, free of distraction, and ready to trade.

And remember, PROTECTIVE STOPS ON EVERY TRADE!

Q&A

Q: Dave, do you day trade at all using your concepts for swing trading?

A:  The concepts do apply. I know those who watch bowties on five-minute S&Ps. I haven't daytraded lately, but do occasionally fire off a daytrade on an intraday pattern, e.g., pullback

Q: It seems volatility is not increasing much?

A: It's choppy -- too choppy! Persistency is necessary. In markets like these, you just have to place smaller bets and trade less.

Q: It seems that with the market lately that intermediate time trading is pretty futile. Swing is even getting to that point. What would you recommend for avoiding the pitfalls of only trading with after-hours information?

A:  I'm assuming you are asking how to improve trades during these tough times. Trade less and be very selective. If you lose on a string of trades, back off and ease back in. Better times will follow. Make sure you save your capital until then.

Q:  Reading yesterday's (1/15/02) chart, I considered (NVDA | Quote | Chart | News | PowerRating) having a pullback pattern. And it triggered impressively above the day before's high. Would you agree with that ? Now with (INTC | Quote | Chart | News | PowerRating)'s poor outlook, it fell hard today. Where would you set the stop limit?

A: It shouldn't take out the 1/14 low. If it does, it may be in trouble.

Q: Do you ever consider volatility, such as ATR, when sizing your position or setting your initial stop?

A: I eyeball the range and how the stock trades. I know when I look at an (NVDA | Quote | Chart | News | PowerRating) or a (GNSS | Quote | Chart | News | PowerRating) or a (BRCM | Quote | Chart | News | PowerRating) that they are volatile puppies, so I adjust accordingly. I would rather be in a volatile stock with fewer shares than a non-volatile stock with a bunch of shares.

Q: Is the TRIN still as effective as it was?

A: I think so. My TRIN Reversal system has had some great signals in the last year or so. Some say that decimalization negates the TRIN, but I disagree. In fact, I love it when people pooh pooh indicators. That's when they start to work again.

Q: Should the time frame of a "trend" be based on a security or can a generic timeframe be applied to all securities?

A: I don't think it should be generic. If a stock makes a big move in a short period of time, I consider it a trend. New issues (remember those?) are a good example of short-term strong trends.

Q: Do you have any systems/patterns that are not revealed in your book that you could share with us?

A: I could tell you, but then I would have to kill you... Seriously, not really. Most of what I do is all spelled out. I do add a layer of discretion, but I talk about that on the website too. I am ALWAYS looking for new patterns -- although I haven't found anything lately. Another thing that you should be doing is studying money management too.

Q: How do you find sectors that are strong and using whose definitions of sectors? It seems that TC200 has one set of sectors, while others have different sets of sectors with more or fewer stocks in the sector.

A: I look at some of those in TC. I also look to the HOLDRS, the optionable sectors (SOX, XBD, etc.) and individual stocks. I like to look at as much as possible. I also look to subsectors, especially when I find a hot stock in a poor overall sector. Looking at lots of stocks each day helps me to find strength/weakness.

Q: Due to the popularity of your book and service, have your signals become less reliable?

A:  I think that the choppy market has more to do with it than anything. People are people. They will always put their twists on things. I don't think I'm famous enough to change how people will trade.

Q:  What is CHADTP and Oscillator swing system you mentioned for market timing? Can you give more details about your three-day average TRIN reading? 

A:  CHADTP equals the five-day average advance minus the five-day average decline. I don't use it as a system, rather an overbought/oversold indicator. My TRIN reversal system uses the three-day average TRIN readings. When they hit an extreme and reverse it, signals a signal. If you don't have my book, e-mail me at sentivetradingco@prodigy.net and I'll give you the exact rules. The Oscillator swing system looks for overbought/oversold 3-10 osc, and then looks to go long/short on an intraday reversal. Again, email me for the rules.

Q: At what point do you start taking partial profits?

A: When profit is greater than initial risk. See the money management articles on the site.

Q: In which cases do you consider turning around, instead of only closing a position?

A: I assume you mean reversing a position. I don't do that in stocks. In the past  have, on volatility plays in commodities, done a stop and reversal. Due to the fact that I co-manage a fund as a CTA, I have avoided trading commodities for a while -- makes life easier with the NFA.

Q: What about swing trading by focusing on the (QQQ | Quote | Chart | News | PowerRating)s?

A: I think Don Miller does a fine job of handling that. Read his stuff. He's pretty good.

Q: How do you determine if you're going to go short or go long on swings? Take now, for instance. Are you shorting swings or going long your swings or out on the sidelines?

A: I try to put the market and sector behind me. If I can't tell the direction, then I back off. I've scaled back on trading during these choppy times.

Q: Could you please explain the volatility factor given in your subscription service?

A: I use historical volatility to measure it. It seems that most of the stocks I pick lately have a high HV, so they get the highest ranking (1). I probably could tweak it a bit -- as almost everything turns out to be a "1."  I do point out when I think something is VERY volatile.

Q: For stock selection, do you start with a scan from site? If so, can you share the scan details?

A: I mostly look at charts...but do run scans for my patterns.

Q: In this crazy market, it seems defining a predefined percentage gain (not too greedy of a percentage) can give better results than follow-up stop-losses, e.g., take an 8% profit as soon as it hits. What are your thoughts?

A: Yes, it seems like the market tempts you with a small profit and then takes it away. Lately, yes, that has been the thing to do, bail out with a small profit. Keep in mind that as soon as this really works (I got an e-mail from someone who told me they are hitting 80%-90% doing this), then conditions will change. Then, you might find yourself risking too much and taking too little profits. When the market trends again, the REAL money in momentum trading will be made by trailing stops. Nothing wrong with recognizing the environment and adjusting to it, though! 

Q: Based on your approach and recent market action, you're likely out of 90% of your long positions. How will you know when to get back in?

A: You are correct. I'll start looking to nibble -- and nibble only -- in this oversold environment, waiting for triggers will help here. Once I get some buy signals and see the market shaping up/holding support, I might look to buy some more. If we break support and start getting sell signals, then I'm back to the short side. Also, I like to watch the 50- and 200-day moving averages. NOTHING MAGIC ABOUT THEM, but they do give you a point of reference.

Q: What's the best way to enter/exit a position if one works and cannot watch the market all day?

A: I like entry stops: buy stops for longs ABOVE the market and sell stops for shorts BELOW the market. As far as taking profits, ideally you should be able to check in at least a few times a day. For instance, (BSX | Quote | Chart | News | PowerRating), a short from my service, was creamed this morning and stayed down for a while, but it did bounce. If you could have checked quotes, you could have seen this and taken some profits. You could also use limit orders at a profit target, but make sure you adjust your protective stop once filled.

Q: Is the best source of potential swing trades on "Trading Markets' Pullback list"?

A: No, the best source is my column and swing trade service! LOL

Q: Hi, Dave. This is my first chat. Is there anywhere I can see summaries of past chats?

A: TraderTalk is a new interactive forum on TradingMarkets.com -- this is only the second in the series so far. Larry Connors ran the first workshop last week (summarized in his "Market Timing Using the VIX). 

I would like to sincerely thank you all for joining me today.