It's tough to make money if you don't know where the price swing began, how far it might carry and when it's finally over. Every aspect of your trade, including holding period and reward/risk, depends on the size of the swing. In addition, swings occur in all time frames, so it's equally important that you know which one you're actually trading.
Measuring the current swing starts with a good set of eyeballs, because swings tend toward proportionality. For example, an 18-to-20-day swing in one direction will often be followed by an 18-to-20-day swing in the opposite direction. To complicate matters, these proportions can be subdivided into fractions, with a rally swinging five days against a 10-day selloff, an eight-day selloff swinging against a 16-day rally, and so forth.
You can also predict swing size by comparing the trend slope against the slopes of prior swings in either direction. Contrary to common sense, more vertical swings usually persist for shorter time periods than more gradual swings. This goes back to basic physics, in which a star that burns the brightest tends to burn out faster than a star emitting a cooler, dimmer light.
This contrast becomes extremely important in reward-targeting and exit-timing, which align closely with the old adage to "buy in mild times and sell in wild times." Above all else, swing trading works in harmony with the highs and lows that stand out on the charting landscape. Trends tend to seek out these levels, which then become price targets for our positions.
Markets move through multiple swings in different dimensions simultaneously. Meanwhile, trends move independently through these time frames until they come into contact with a larger-scale swing, which then takes priority. This alignment tells us to hang tough when we're playing a large-scale swing and to not give up on the position just because it's moving against us in a smaller time frame.
Simply stated, the most profitable positions turn up when there are few barriers between your entry and the swing you're trading and many barriers between your entry and the swing's inception point. Notably, it's easy to train your eyeballs to find these favorable patterns when flipping through the charts, doing your nightly analysis.
The optimized holding period (OHP) denotes the length of the trade that will produce the most profitable outcome. The OHP for any position combines your strategy with accurate swing analysis. Ask yourself the following question when you find a promising opportunity: How far can it go before hitting the next obvious barrier? The answer is more important than the pattern itself, because it doesn't matter if a stock breaks out when it has nowhere to go.
Let's look at a bullish setup in the financial sector that relies on accurate swing analysis.
rallied to $19.50 during September's "Paulson spike" and sold off to an all-time low at $3.55 in February. It then retraced 62% of this 16-point swing in a strong rally that ran out of steam in May. The subsequent pullback has dropped price into support at the 200-day moving average, where the stock is starting to perk up.
There are over 8 points from the current price to the September swing, suggesting excellent reward potential. On the flip side, new positions can be sold on a breakdown of 200-day moving average support, which yields a risk target just under $10. This measures out to an initial reward-to-risk profile in excess of 7 to 1.
However, the stock faces one major barrier in the potential swing up to the high at $19.50. The May pullback started at the October breakdown from support at $14.25. This now limits actual reward potential to a test of the last high, which is still a decent trade, with 3 reward points and 1 downside point into a stop loss.
Traders can choose to play the larger-scale or smaller-scale swing, as long as they adapt their holding periods to fit this specific pattern. To accomplish this task, we need to look at the time element in several different dimensions. First, it took 111 trading days from the September high to the February low. The current uptrend has now persisted for 71 trading days.
This predicts that a continued uptrend from the current price level into last September's swing will take about 40 trading days. Of course, that number is just a target, because this isn't an exact science. It does suggest, however, that the stock could rally up to $19.50 by then end of July or early part of August, perhaps in response to earnings season.
The short-term trade into the May high requires a different swing analysis. When a stock moves from a correction back into its primary uptrend, the rally should make up lost ground with a swing size that's smaller than the preceding pullback. We can estimate this length by counting the number of downtrend days and then sub-dividing it by one half.
In this pattern, Blackstone topped out on May 6 and started to pull back. It bounced 21 trading days later, although it hasn't confirmed the new upswing just yet. The four-day low, as long as it holds, predicts a two-week recovery period that will end with the stock back above $14 around June 24.
Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.
Know What You Own: In Wednesday's trading, the most active stocks include Citigroup (C) - Get Report,Bank of America (BAC) - Get Report, the S&P Depositary Receipts (SPY) - Get Report, the Financial Bear 3X (FAZ) - Get Report, the Financial Bull 3X (FAS) - Get Report,the Financial Select SPDR (XLF) - Get Report and the PowerShares QQQ (QQQQ) .
At the time of publication, Farley had no positions in stocks mentioned, although holdings can change at any time.
Alan Farley is a private trader and publisher of
Hard Right Edge
, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of
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