swing trading

Swing Trading Strategies

            A swing trader invests a modest amount of time trading a stock; with a momentum slower than that of the day trader, but faster than a long term investor. This paper presents an explanatory study of swing trading theory along with the breakouts; gap filling; and dead cat bounce strategies.

1.1 Overview

            On average, swing trades lasts between two days to two weeks; whereas, day trades positions are closed out at the end of the trading day. A swing trader builds his watch-list when markets are closed, looking for stocks that are forming familiar patterns with high probability predictable outcomes, he then only trades off his watch-list the following day. An expert trader would only trade stocks that made a move on significant volume, as volume represents the market's conviction on that move.

            The swing trading style can be identified based upon speed; a modest amount of time to monitor market movement; and aggressive buying and selling trading strategies. Volatility drives the bigger swings within the trading account which demand efficient risk management strategies. Swing traders conduct top-down or bottom-up search for patterns and capitalize on market trends using either fundamental or technical analysis. The events may be depicted by potential or actualized swing points that are exhibited on the candlestick bars.  More specifically, these strategies depend upon technical chart pattern in order to time entries and exits from the markets. Figure 1 shows the difference in trading styles for trading pattern searches on the Japanese candlestick chart, using technical analysis:

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Figure 1. Diversification in Trader Technical Analysis of Chart Pattern

The blue circle pattern depicts a breakout trading strategy; while the green circle patterns depict the “novice” trader. The orange circle pattern depicts behaviors that support momentum traders. The red circle pattern depicts the swing trader behaviors, as the momentum traders have been stopped out; much of the novice traders have shorted; and the resistance converts to support.

1.1.1 Bullish and Bearish Swing Trades

            The basics of bullish and bearish approaches vary in regard to the choice of trends. A substantial number of traders loss are the outcomes of traders being on the wrong side of the market too often without considering joining the other side, even when the technical signals lean that way. (Velez, 2008) contributed that “typically, neither the bears, nor the bulls can win consistently for more than 5 rounds; but rather, each side will likely surrender to the other after 3 to 5 consecutive victories”.

            The bullish swing trader is driven by greed in the upward trend, as the traders searches for uptrends with pullbacks or reversals; entering trades when the price movement reenters the initial uptrends. The uptrends are characterized by higher highs and higher lows in which the trader will buy dips/declines and breakouts. The minimum to enter may be a set two-to-one reward-to-risk ratio. The profit targets for bullish traders are commonly the peak point of the uptrend; while the stop out may be the lowest point of the pullback.

            The bearish swing trader plays the downtrends to gain profit when the bear continues to rally downward. The downtrends are characterized by lower highs and lower lows. Here, the trader will sell short rallies and breakdowns. The swing trader will typically enter a position when the trend low extends below the low pf the prior market day. The bearish trading period is driven by fear, which eventually climaxes with some gains for those with appropriate timing (Velez, 2008). The stop out is the highest price the stock reached in the most recent countertrend. The profit target would be the lowest price in the most recent trend. The trade may be initiated with a sell-stop limit order; or for options, the contingent order.

When the market is going sideways, there are relatively equal numbers of highs and lows, within sideways markets, the swing trader may buy dips, sell rallies, or both.

2. Swing Trading Strategies

            The following strategies depend heavily upon market timing, high volumes, and volatility risk management. The objective of any successful swing trading strategy is to identify an early stage of a trends, and capture the gains on high volume momentum. Opportunities for swing traders lie in prospective income streams; diversification; and profits from declining prices and shorting. (Ferguson, 2009) proposed 5 rules for swing traders to follow:

1) Swing trade trending stock

2) Purchase pullbacks

3) Trade the first pullbacks

4) Utilize  a multiple time frame analysis

5) Trade with the market; rather than against it

The buy setups may be simple, based upon criteria of 3 consecutive moves to identify the trend, and with the potential to capture gains between 1 to 5 bars on the upside. The short setup may also be simple with the potential to capture 2 to 5 day gains. The commission rates for a swing trader are also extremely lower compared to that of a day trader.

            Some swing trades prefer to initiated their trades with a buy-stop limit order; while the options are initiated with contingent buy orders. The assumed risk is the difference between the entry point and the stop out point. When the stock or option reaches the target price, the swing trader enters a one-cancels-other order to take profit. Further, the swing trading strategies are designed to follow the price action using fundamental or technical analysis that use indicators to identify and validate trends. Locating the buying and selling pressure is typically achieved by following the trends. In instances in which no bullish or bearish trend is apparent, the swing trader may take short and long positions near the resistance and support areas, respectively.

2.1 Breakout Strategies

            The breakout strategy is an active trading approach in which the trader enters the market and takes a position within the early stages of the trend, it is one of the most successful strategies that has simple rules, yet great returns. The simplest way to describe it is this,  the trend has expanded beyond a critical level of support or resistance and the volume and volatility are increasing. The benefit of the breakout strategy is to fully capitalize upon early entry into trends that play out to be major price movements. Such movements are driven by world events, or catalysts, that when announced, become deeply embedded into associated security prices. 

2.1.1 Breakouts with Catalyst

            The breakout with catalyst strategy focuses upon small and midcap assets that are trading in strong patterns against substantial resistance or just beneath the primary breakout spot. The strategy is based upon price movements that are driven by a catalyst. The catalyst is a highly impactful, current event, such as the United States’ Presidential election outcomes; the commodities run; and the United Kingdom’s exit from the European Union which are generally unpredictable; therefore, the announcements quickly become deep reflections in the market condition. The release of news catalyst will prompt large institutional investors to either accumulate or sell off significantly sized quantities of market shares. Breakout volumes that expand beyond recent market activities confirm the strength of the trend.

            Catalysts dramatically impact the stock price movement due to the timing of the news release and the socioeconomic magnitude of the content. Swing traders typically locate and validate the catalyst that will drive high volume beyond resistance and subsequent breakout. The technical pattern indicator for strong breakout signals includes uptrends with increasing volume. Breakouts from consolidations are generally selected when accompanied by prior uptrends and sideways behaviors with high resistance. Volume is confirmed in the uptrend when the price closes above the prior highest swing point on an increased volume and is and ranked as high potential for continuation when the close occurs above the prior highest swing point on a decreased volume. Figure 2 shows the swing points and volume serve as indicators of the trend for the swing trader:

swing trading strategies

Figure 2. Volume as a confirmation Indicator

The breakout levels are often revisited over time, experienced trader know that these levels are areas rather than just a single price point, the testing of these areas create inflection in cases where the differences in volume are substantial. The area in which the breakout candle volume over the swing point is higher in fig. 2, which serves as an indicator that the trend is confirmed. In the event that the candle breakout volume had been lower, the probability of the trend would have also been lower. In the event that the trader purchases a pullback between the green bars and the stock breaks out the prior swing point, the swing trader may opt to hold the position based upon the confirmed probability of a continuing uptrend. On the second pullback, the trader may opt trade based upon the breakout from the prior highest swing point based upon the increased volume.

            Massive breakouts will create substantial pre-market volume and gaps that provide indications based upon the type of charts patterns the swing trader uses to identify the trends. The 3 Bar Volume breakouts are reflected in candlestick chart patterns wherein the stock is in uptrend and the volume bars are increasing sequentially, by day, for 3 days. The third bar is the tallest bar in the pattern and the slope of the trend line across the bars is an approximately 45 degree breakout. In instances in which the trend line is in an opposite pattern, a market entry position would be delayed.

            Extreme fluctuations in company earnings, bankruptcies, and other forms of critical financial information can serve as catalysts; particularly news that was unexpected. In order to successfully capitalize upon the catalyst breakout, the swing trader must have the capacity to fully comprehend the impact of the catalyst.  In this light, a recent catalyst of massive magnitude can become the platform for a game changing trade, as daily news reports generally do not contain globally life changing or economy changing events.  Therefore, the swing trader will trade aggressively in markets with strong catalysts that are a big surprise; and will trade conservatively in milder market conditions.

2.1.2 Donchian Channel Breakouts

            The Donchian Channel was created by Richard Donchian as a support and resistance type moving average indicator. The Donchian Channel indicates the support and resistance of the security; and thus, is used to determine volatility and to identify long and short positions. Since its release, several channel trading strategies, such as channel breakouts, have been developed and combined with other strategies, such as the channel plus stochastic oscillator or MACD, in order to decrease false signals and increase the clarity of the trading scenario. 

            The channel breakout may be identified using daily charts to locate volatile markets that have become less volatile during the trading range of between one week to 2 weeks. The channels on the upside direct the swing trader to only trade up; while the downward channel is an indicator to trade down; and the tight channels present the least risk. After the channel is identified, the swing trader waits for gaps to open; disregarding trades that are going short on the upside. The order is for two ticks higher than the gap day high and the stop is placed below the gap day low.  The entry price is measured as the distance between the entry price and the stop; multiplied by 4; and added to the entry price. At this price point, the trader may take profit. This is an advanced strategy that needs a strong understanding of the market auction process and volatility changes, using this strategy without this knowledge will result in trading a lot of false signals.

3. Gap Filling

            Areas within the Japanese Candlestick stock chart in which no trading occurs are referred to as gaps. The size of the gap may be a period of minutes, hours, or days. The gap occurs when the stock price rises to a higher bid price that is above the most recent closing price and never returned to the initial point of the gap. This instance is made possible due to the buy and sell orders that are placed prior to the market open that drive the price higher or lower than the closing price. When the price falls, the stock has “gapped down”; and when the price rises, the stock has “gapped up”. For swing traders, the points of interest are gaps that occur on the daily chart.

            Gaps are considered to be vacuums in the chart space and are commonly categorized as either breakaway, continuation or exhaustion gaps. The trading strategies may be based upon the type of gap and the associated indications for the trend. Figures 3 and 4 show breakaway and continuation gaps on the candlestick chart, respectively:

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Figure 3. Breakaway Gap

day trading

                   Figure 4. Continuation Gap

The breakaway gap setup is comprised of the developed range breakout; a sizeable gap that results from developed range; high volume as associated with the prior volume; and a breakout based upon tangible news. The continuation gap, or “measuring”, or “runaway” gap, occurs in the midpoint of strong trends, in which the stock prices appears to be “running away” due to pullbacks that are short and small. The bullish runaway gap exhibits sharp increasing price action, followed by the gap; while the bear runaway gap exhibits sharp decreasing price action, followed by the gap.

            The exhaustion gap occurs at the end of a movement, and is characterized by little or no upward movement on the following market day. The exhaustion commonly occurs as a result of a decrease in demand for the stock; and often times is only temporary. The exhaustion gap may typically close within one trading week; which is an indicator that the trend has reached its peak. 

            Company earnings news reports are common drivers of gaps, as market discounts due to new information. The gaps typically will reflect extreme conditions that have been presented in the news or the release of other information that is price sensitive. In this light, morning reversal gaps occur within the first hour of trading after the market opens; as market manipulations of the opening stock price can drive reversals.

            Gaps typically close when swing traders set stops at or below the point the gap was created. The computer trading platform may then run the stops until all final stops are filled or positioned below the gap. When the stock price gaps up or down, it may rally back to the price level where there were no trades and fill gap.

            Swing traders mitigate the gap risk by avoiding holdings prior to company earnings; sound position-sizing and diversification; and higher reward-to-risk ratio objectives. Swing traders profit by purchasing oversold gap fill set ups. Ideal stock movements that are used as indicators are typically short, rapid pull backs in the stock price. In instances when the swing trader holds a position overnight, gap risk becomes a premium risk management concern. The trade risk may be heightened in regard to gap past intended entry prices and gap past stop loss orders.  Gaps may occur across the stop loss order, triggering the order to the opening stock price. Further, the drivers of the gap are significant; or more specifically, whether the gap was caused by experienced traders or by amateurs.  

3. Dead Cat Bounce

            (Bulkowski, 2005) presented the Dead Cat Bounce as a means to define event patterns that exhibit bizarre price declines. Within the dead cat bounce event, prices drop dramatically, bounce and resume decline at modest rates. The ongoing decline is periodically interrupted by small recovery periods in which the price increases temporarily. The bounce is characterized by the price gap, trend low, bounce, post bounce decline and the second bounce. Figure 5 shows the dead cat bounce at the JKSE open in 2015:

another swing trade

Figure 5. Dead Cat Bounce

The event reflects massive selling; a broken uptrend; and continuously declining prices. The bounce occurs after the broken uptrend and exhibits a significantly continuous price decline.

The parameters of the dead cat bounce consist of:

1) Price gap - Price trends in a downward gap and closes lower than the previous day by 15% to 70%.

2) Trend low - The trend of 40% low makes a lower low on the following day; 17% continues lower the following day; followed by 9% and 3%.  The trend low averages at 7 days from the event day.

3) Bounce - Following the decline on the event day, the price bounces. A 22% move will close the gap during the bounce; a 38% move will close the bounce in 3 months; and a 58% move will close the gap within 6 months. The average bounce height requires 23 days and is typically from the event low to a height of 28%.

4) Post bounce decline - Upon the completion of the bounce, the price resumes a decline with an average of 30% from the high to a low within 49 days. Approximately 67% of the time, the price average will place 18% below the event low.

5) Second dead cat bounce - 26% will reflect a second bounce that measures 15% in 3 months and 38% in 6 months.

The size of the bounce is proportional to the size of the event day decline and the time required for the price  movement to hit the bounce high. The swing trader may buy in near the trend low and ride the price movement upward to the bounce phase when the decline is substantial. An inverted dead cat bounce reflect price movements that are the opposite of the dead cat bounce. The inverted bounce is depicted by price increases of a minimum of 5%.

4. Conclusion

            Swing trading is at the heart of swingalpha.com and is a popular trading strategy that has increased in participation with the advancements in computer technology. This style of trading is speculation of microcap to high value stocks and option trades that are endure from days to two weeks. Several strategies have been developed to identify trends and to establish when to exit or when to take profit. The potential income for swing traders is comparable to that of day traders within comparable time frames. Advanced topics of market profile theory are not discussed in this paper, but hopefully will be in future releases.


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Velez, O. 2008. Swing Trading. John Wiley & Sons.

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