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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: Wiley Trading Series
- Sprache: Englisch
- Veröffentlichungsjahr: 2013
Comprehensive coverage of the four major trading styles Evolution of a Trader explores the four trading styles that people use when learning to trade or invest in the stock market. Often, beginners enter the stock market by: * Buying and holding onto a stock (value investing). That works well until the trend ends or a bear market begins. Then they try * Position trading. This is the same as buy-and-hold, except the technique sells positions before a significant trend change occurs. * Swing trading follows when traders increase their frequency of trading, trying to catch the short-term up and down swings. Finally, people try * Day trading by completing their trades in a single day. This series provides comprehensive coverage of the four trading styles by offering numerous tips, sharing discoveries, and discussing specific trading setups to help you become a successful trader or investor as you journey through each style. Trading Basics takes an in-depth look at money management, stops, support and resistance, and offers dozens of tips every trader should know. Fundamental Analysis and Position Trading discusses when to sell a buy-and-hold position, uncovers which fundamentals work best, and uses them to find stocks that become 10-baggers--stocks that climb by 10 times their original value. Swing and Day Trading reveals methods to time the market swings, including specific trading setups, but it covers the basics as well, such as setting up a home trading office and how much money you can make day trading.
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Contents
Cover
Series
Title Page
Copyright
Preface
EVOLUTION OF A TRADER
CONTENT OVERVIEW
INTENDED AUDIENCE
Acknowledgments
Chapter 1: Introduction to Swing Trading
WHAT IS SWING TRADING?
WHO SHOULD SWING TRADE?
A SWINGING EXAMPLE
LOOKING AHEAD
CHAPTER CHECKLIST
Chapter 2: Swinging Techniques
QUICK REVIEW: SUPPORT AND RESISTANCE
TRENDLINE TRADING
TRADING USING CHANNELS
THE THREE-BAR NET LINE SETUP
FIRST THRUST PATTERN FOR SWING TRADING
CHAPTER CHECKLIST
Chapter 3: Swinging Chart Patterns
WHICH CHART PATTERNS WORK BEST FOR SWINGERS?
TRADING THE HIGH AND TIGHT FLAG
HTF TRADE IN INSTEEL INDUSTRIES
FISHING FOR INVERTED AND ASCENDING SCALLOPS
SCALLOP TRADING TIPS
TWICE IS NICE: EVE & EVE DOUBLE BOTTOMS
TRADING EVE & EVE
TOP SEVEN FREQUENTLY TRADED CHART PATTERNS
MY FAVORITE CHART PATTERNS
SWINGING THROWBACKS AND PULLBACKS
TRADING EXAMPLE
CNO THROWBACK ENTRY
MEASURING SWINGS
FTO TRADE
CHAPTER CHECKLIST
Chapter 4: Swing Selling
SELLING IDEAS
TOP 20 CHART PATTERN PERFORMERS
DIAMOND TOPS AND BOTTOMS
COMPLEX HEAD-AND-SHOULDERS TOP
THE EIGHT BEST EXIT SIGNS
TEN FAVORITE SELL SIGNALS
TRADING EXAMPLE: THE TERADYNE EXIT
TRADING EXAMPLE: EXITING FOREST
TRADING EXAMPLE: SWINGING CNO
CHAPTER CHECKLIST
Chapter 5: Event Pattern Setups
COMMON STOCK OFFERINGS SETUP
SURVIVING A DEAD-CAT BOUNCE
THE INVERTED DEAD-CAT BOUNCE SETUP
TRADING DUTCH AUCTION TENDER OFFERS
EARNINGS SURPRISE SETUP
EARNINGS FLAG SETUP
STOCK UPGRADES AND DOWNGRADES
STOCK SPLITS
SETUP: TRADING REVERSE SPLITS
CHAPTER CHECKLIST
Chapter 6: Swinging Tools and Setups
THE CHART PATTERN INDICATOR
THE SWING RULE
PUMP UP THE VOLUME OR NOT
SELECTING WINNERS USING INDEX RELATIVE STRENGTH
THREE SWING TRADING SETUPS
TRADING SETUP: SIMPLE MOVING AVERAGE TESTS
THE SMILE AND FROWN SETUP
TRADING SMILES AND FROWNS
SMILE AND FROWN TRADING TIPS
CHAPTER CHECKLIST
Chapter 7: Introduction to Day Trading
WHAT IS DAY TRADING?
WHY DAY TRADE?
IS DAY TRADING FOR YOU?
WHAT ARE THE PROBLEMS OF DAY TRADING?
CHAPTER CHECKLIST
Chapter 8: Day Trading Basics
MANAGING EXPECTATIONS: HOW MUCH CAN YOU REALLY MAKE?
BUILDING THE HOME OFFICE
OFFICE SETUP COST
PATTERN DAY TRADING RULES
WASH SALE RULE
EIGHT TIPS FOR PICKING STOCKS TO DAY TRADE
PRICE REVERSAL TIMES REVEALED!
WHAT TIME SETS INTRADAY HIGH AND LOW?
INSIDE LEVEL II QUOTES
HEARTBEAT OF THE MARKET: TIME-AND-SALES TICKER
PRE-MARKET CHECKLIST
AFTER-MARKET ANALYSIS
CHAPTER CHECKLIST
Chapter 9: Opening Gap Setup
OPENING GAP TEST DATA
SETUP: FADING THE OPENING GAP
SAMPLE TRADE
CHAPTER CHECKLIST
Chapter 10: Day Trading Chart Patterns
DAY TRADING DOUBLE TOPS
DAY TRADING TRIPLE TOPS
DAY TRADING SYMMETRICAL TRIANGLES
DAY TRADING HEAD-AND-SHOULDERS TOPS
DAY TRADING DOUBLE BOTTOMS
DAY TRADING HEAD-AND-SHOULDERS BOTTOMS
DAY TRADING TRIPLE BOTTOMS
OTHER TRADING TIPS
CHAPTER CHECKLIST
Chapter 11: Opening Range Breakout
WHAT IS BEST RANGE TIME?
THE ORB SETUP
DOES THE ORB SETUP WORK?
CHAPTER CHECKLIST
Chapter 12: Ten Horror Stories
THIS IS A WINNER, MOM. BUY IT!
THREE NEWSLETTER DISASTERS
THREE OPTION AND WARRANT DISASTERS
TWO MISSED OPPORTUNITIES
THE $1 MILLION SURPRISE
Chapter 13: Closing Position
Chapter 14: What We Learned
Visual Appendix of Chart Patterns
Bibliography
OTHER SITES OF INTEREST
About the Author
Index
Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding.
The Wiley Trading series features books by traders who have survived the market’s ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future.
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Library of Congress Cataloging-in-Publication Data:
Bulkowski, Thomas N., – Swing and day trading : evolution of a trader / Thomas N. Bulkowski. p. cm. – (Wiley trading series) Includes bibliographical references and index. ISBN 978-1-118-46422-9 (cloth); ISBN 978-1-118-51696-6 (ebk); ISBN 978-1-118-51697-3 (ebk); ISBN 978-1-118-51699-7 (ebk) 1. Investment analysis. 2. Portfolio management. 3. Electronic trading of securities. 4. Day trading (Securities) I. Title. HG4529.B85 2013 332.64–dc23 2012033910
Preface
Are you like John?
He learned early in life to save his money for a rainy day. Instead of putting it into the bank, he put it into the stock market. He bought Cisco Systems in mid-1999 at 35 and watched the stock soar to 82 in less than a year.
“I’m looking for my first 10-bagger,” he said, and held onto the stock.
In 2001, when the tech bubble burst, the Cisco balloon popped, too, and it plunged back to 35. He was at breakeven after seeing the stock more than double.
“It’ll recover,” he said. “It’s a $200 stock. You’ll see.”
The stock tunneled through 35 then 30, then 20, and bottomed at 15, all in one month. When it hit 10, he sold it for a 70 percent loss.
“I should have sold at the top. Buy-and-hold doesn’t work.” But it did work. Cisco more than doubled, but he held too long.
Next, he tried position trading to better time the exit and chose Eastman Chemical. He bought it in 2003 at 14, just pennies from the bear market bottom, and rode it up to 21 before selling. He made 50 percent in a year. Was he happy?
“I sold too soon.” The stock continued rising, hitting 30 in 2005. He disliked seeing profits mount after he sold, and wanted to profit from swings in both directions.
He switched to swing trading in 2005 and tried his old favorite: Cisco. The stock bounced from 17 to 20 to 17 to 22 over the next year, but he always bought too late and exited too early. He made money, but not enough.
He took a vacation from his day job and watched Applied Materials wave to him on the computer screen, inviting him to come day trade it. So he did. He made $400 in just 15 minutes. “If I can make $400 a day for a year, I’ll make”—he grabbed his calculator and punched buttons—“$146,000! No, that’s not right. How many trading days are there in a year?”
He redid the math and discovered that he could make $100,000 a year by nibbling off just 40 cents a share on 1,000 shares every trading day. “Wow. Count me in.”
After paying $5,000 for a trading course and more for hardware, software, and data feeds, he took the plunge and started day trading full time.
It took a year to blow through his savings. Another three months took out his emergency fund. He moved back in with his parents while he looked for a real job.
Now, he is saving again and putting it to work in the market. “After reading the manuscript for this book,” he said, “I found a trading style that works for me. I’m a swinger—a swing trader. And I’m making money, too.” He handles not only his own money but his parents and siblings as well, providing them with extra income and building a nest egg for their retirement.
EVOLUTION OF A TRADER
John represents an amalgam of traders, a composite of those searching for a trading style that they can call their own. He suffered through many failed trades before finding a trading style that worked for him. I wrote the Evolution of a Trader series to help people like John.
Evolution of a Trader traces my journey from a buy-and-hold investor to position trader to swing trader to day trader as I searched for styles that worked best when markets evolved. However, these are not autobiographical. Rather, they are an exploration of what has worked, what is supposed to work but does not, and what may work in the future.
This series dissects the four trading styles and provides discoveries, trading tips, setups, and tactics to make each style a profitable endeavor. I have done the research so you do not have to. I show what is needed to make each style work.
CONTENT OVERVIEW
The three books in the Evolution of a Trader series provide numerous tips, trading ideas, and setups based on personal experience and that of others.
Easy to understand tests are used to confirm trading folklore and to illustrate ideas and setups, and yet the books are an entertaining read with an engaging style that appeals to the novice.
Each section has bullet items summarizing the importance of the findings. A checklist at chapter’s end provides an easy-to-use summary of the contents and reference of where to find more information.
At the end of each book is a topic checklist and reference.
Trading Basics
The first book in the series begins with the basics, creating a solid foundation of terms and techniques. Although you may understand market basics, you will learn from this book.
How do I know? Take this quiz. If you have to guess at the answers, then you need to buy this book. If you get some of them wrong, then imagine what you are missing. Answers are at the end of the quiz.
From Chapter 2: Money Management
From Chapter 3: Do Stops Work?
From Chapter 4: Support and Resistance
From Chapter 5: 45 Tips Every Trader Should Know
From Chapter 6: Finding and Fixing What Is Wrong
The answer to every statement is true.
Fundamental Analysis and Position Trading
This book explains and describes the test results of various fundamental factors such as book value, price-to-earnings ratio, and so on, to see how important they are to stock selection and performance.
The Fundamental Analysis Summary chapter provides tables of fundamental factors based on hold times of one, three, and five years that show which factor is most important to use for those anticipated hold times. The tables provide a handy reference for buy-and-hold investors or for other trading styles that wish to own a core portfolio of stocks based on fundamental analysis.
Chapters such as “How to Double Your Money,” “Finding 10-Baggers,” and “Trading 10-Baggers” put the fundamentals to work. The chapter titled “Selling Buy-and-Hold ” helps solve the problem of when to sell long-term holdings.
Position Trading
The second part of Fundamental Analysis and Position Trading explores position trading. It introduces market timing to help remove the risk of buying and holding a stock for years.
Have you heard the phrase Trade with the trend? How often does a stock follow the market higher or lower? The section in Chapter 19 titled, “What Is Market Influence on Stocks?” provides the answer.
This part of the book looks at how chart patterns can help with position trading. It discloses the 10 most important factors that make chart patterns work and then blends them into a scoring system. That system can help you become a more profitable position trader when using chart patterns.
Six actual trades are discussed to show how position trading works and when it does not. Consider them as roadmaps that warn when the road is bumpy and when the market police are patrolling.
Swing and Day Trading
The last book of the series covers swing and day trading. The first portion of the book highlights swing trading techniques, explains how to use chart patterns to swing trade, and explores swing selling, event patterns (common stock offerings, trading Dutch auction tender offers, earnings releases, rating changes, and so on), and other trading setups.
It tears apart a new tool called the chart pattern indicator. The indicator is not a timing tool, but a sentiment indicator that is great at calling major market turns.
Day Trading
Day trading reviews the basics including home office setup, cost of day trading, day trading chart patterns, and the opening range breakout. It discusses research into the major reversal times each day and what time of the day is most likely to set the day’s high and low—valuable information to a day trader.
An entire chapter discusses the opening gap setup and why fading the gap is the best way to trade it. Another chapter discusses the opening range breakout setup and questions whether it works.
Ten horror stories from actual traders complete the series. They have been included to give you lasting nightmares.
INTENDED AUDIENCE
The three books in this series were written for people unfamiliar with the inner workings of the stock market, but will curl the toes of professionals, too.
Research is used to prove the ideas discussed, but is presented in an easy to understand and light-hearted manner. You will find the books to be as entertaining as they are informative and packed with moneymaking tips and ideas. Use the ideas presented here to hone your trading style and improve your success.
Whether you are a novice who has never purchased a stock but wants to, or a professional money manager who trades daily, these books are a necessary addition to any market enthusiast’s bookshelf.
Acknowledgments
So many people are involved in bringing a manuscript to life, and I play a small role. To all of those workers at John Wiley & Sons, I say thanks for the help, especially to Evan Burton and Meg Freeborn. They ironed the wrinkles and made the trilogy presentable, even fashionable.
CHAPTER 1
Introduction to Swing Trading
Swing trading reminds me of standing on the shore of an ocean, watching the waves. Each wave has a crest and trough—a swing from high to low or low to high that mimics the up and down motion of stocks. Swing traders do not try to surf that wave by riding near the crest, but by sailing their boat from trough to crest like in scenes from The Perfect Storm.
WHAT IS SWING TRADING?
There are two types of swing trading styles. The first is to range trade, that is, buy and sell as price bounces between a low and high price. If you know what a rectangle chart pattern is or a channel, then you can buy near the bottom and sell near the top repeatedly. I find that the profit potential of range trading is not exciting enough for me.
Range trading is buying and selling as price bounces between highs and lows.I prefer to catch a swing as soon as it starts and hold it until it ends. It is the same idea as a range trade but the high–low range is often much larger (if you are lucky) and you only trade it once.
A trend trade buys near the swing low and sells near the end of a short-term trend (or the reverse: sell high and buy low).Swing trading is trying to catch price as it moves between peaks and valleys. Another way to say this is that swing trading is capturing the move between layers of support and resistance.
Why not just hold onto the stock and ride it? You can do that, of course, but swing traders believe that they can increase profits by participating as the stock oscillates up and down like waves on a pond.
Look at Figure 1.1. If investors bought the stock at A and sold it at E, they would have made almost nothing since price did not change between those two points. However, perfect swing traders would sell short at A, cover at B and buy long, sell at C and go short, and so on, profiting from each swing of the stock. They could have captured roughly $3 per share on each of the AB and BC moves, and $2 on each of the CD and DE moves for a total of $10 per share. That is not bad for a stock that ends where it begins.
FIGURE 1.1 This trade shows a perfect entry and sale on the day the stock peaked. Trailing stops mark the way higher.
WHO SHOULD SWING TRADE?
As the hold time for a trade shortens, there is less room for error. You can ignore a stock for years using a buy-and-hold strategy and still turn a profit. With swing trading, a trader’s skills need to identify turning points with accuracy. One mistake can be costly, which is why stop placement is important.
Swing trading demands a different personality than the longer hold time brethren. While a buy-and-hold investor watches autumn leaves changing color on the back porch, a day trader is injecting caffeine and hanging onto the computer desk, knuckles white. A swing trader is not as nervous as a day trader, but you get my point. Swing traders have to pay closer attention to their trades than do those with a longer hold time horizon.
One novice swing trader I know waits for his favorite stocks to drop by 20 percent before he buys. Then he closes his eyes and waits for them to recover, hoping for a 30 percent move before he cashes out. He turned an investment of $25,000 into almost $100,000 in a year using this simple idea.
He has three keys to success. First, he chooses to ignore mistakes. If the stock continues to drop, it turns into a buy-and-wait-for-recovery trade, praying for breakeven. Second, the stocks were also cheap, in the $2 to $4 range (like Citigroup) with high volatility. In the days of the banking crisis (2009), he could peel off a 30 percent gain in about three days, but would become trapped in a loser for weeks. Fortunately for him, his picks recovered and allowed him to minimize losses. Third, the banking industry was in turmoil, making large swings every few days, catering to his trading setup.
He enjoys this fast-paced trading action. It is not day trading, so he can still monitor his stocks a few times each day from his day job without getting into trouble. Recently, though, the setup has not been working as well as in the past. He has moved from banking stocks to housing stocks, and those do not bounce around as much. Any recovery for a losing position now takes not weeks but months.
Swing trading is best suited for people who are accustomed to using stops and like to follow the market daily.A SWINGING EXAMPLE
Perfect trades are rare, but I have made a surprising number. I am not claiming to be a perfect trader—not by a long shot—but the timing on some of them is well done. A trade in Exxon Mobil Corp. (XOM) is a particularly good example of a nearly perfect swing trade. Figure 1.1 shows the setup.
On one of the passes through the nearly 700 securities that I look at, I spotted a rare bird: an ascending triangle. Normally I dislike trading ascending triangles because price rises 5 to 10 percent before reversing.
I logged the ascending triangle into my database two days before the breakout and then started my research. After looking at other stocks in the industry, I concluded that the oils were boiling, and I wanted to participate. I placed a buy stop at 52.06, which is a penny above the top of the triangle.
I scored the chart pattern and this one had a –1 score, meaning it was unlikely to reach the 65.91 price target.
Using the height of the chart pattern projected a more conservative target of 55.20, a gain of about three points over the expected fill price. I will explain the measure rule for calculating price targets in Chapter 3 (under the heading “Measuring Swings”).
The company released earnings the day before the breakout. The next day (E), the buy stop filled a penny higher because price blew the lid off the top of the ascending triangle.
I always assume a throwback will occur, but it did not. Price just kept on rising. After entering the trade, I placed a stop at 49.21 that same day. I positioned the stop below the bottom of the chart pattern using the minor low (D) at the start of January as the reference.
As price climbed, I raised the stop as the chart shows, to 51.07. On February 10, I raised the stop to 52.93, using a 62 percent Fibonacci retrace of the move up from January 28 low (51.11, two days before the breakout) to the current high of 56.62, minus about 25 cents.
On February 16, I raised the stop to 53.93, again using a 62 percent Fibonacci retrace to price the stop. Two days later, I wrote in my notebook: “Stop raised to 55.93. I am getting nervous about the straight-line run, so I am tightening up the stop. A quick decline often follows a quick rise, so. . . .”
I continued to raise the trailing stop and ended with it at 61.15. However, in a late-day sell off, the stock blew through my stop and filled at 60.90.
On the day I sold, the stock reached a new high of 64.37, fulfilling the scoring system’s prediction that it would not reach 65.91.
Selling was the right move since the stock tumbled back to a low of 52.78 in less than three months. I captured a dividend payment during the hold time, giving me a net gain of 17 percent.
Why do I consider this a perfect swing trade? Entry was within 2 cents of the optimum breakout price and the stock peaked on the day I sold. Yes, the stop cashed me out near the low for the day, but that happens sometimes. Seeing the stock tumble after I sold gave me a warm feeling inside, but it could have been the jalapeños I ate.
The ExxonMobil trade started with the breakout from an ascending triangle and ended using a stop.LOOKING AHEAD
The pages that follow discuss the techniques that I use to swing trade and some tips from others. Since I like chart patterns, I will discuss event patterns and how you can profit from them. Those can be quite important for swing traders because the patterns have an opportunity to repeat periodically (such as every quarter).
The inverted dead-cat bounce is one of my favorites. Not only do you cash out when price shoots up, but you cannot beat the feeling of price confirming it by tumbling after you exit.
The event pattern is an easy way to capture profits. Sometimes price continues rocketing skyward after you sell, but the probabilities suggest a return to earth. I have developed a fondness for parachutes instead of moon shots. Perhaps you will, too, after reading about the inverted dead-cat bounce.
I have discussed busted chart patterns but they deserve another look. They represent a low-risk, high-success setup, and in Chapter 3 I discuss how to profit when you see them.
CHAPTER CHECKLIST
Range trading is buying and selling as price bounces between highs and lows. See “What Is Swing Trading?”
A trend trade buys near the swing low and sells near the end of a short-term trend (or the reverse: sell high and buy low). See “What Is Swing Trading?”
Swing trading is best suited for people who are accustomed to using stops and like to follow the markets daily. See “Who Should Swing Trade?”
The Exxon Mobil Corp. trade started with the breakout from an ascending triangle and ended using a stop. See “A Swinging Example.”
CHAPTER 2
Swinging Techniques
The key to swing trading is learning to identify when price is going to turn. If you can do that, then it is easier to profit from a move.
Figure 2.1 shows an example of how that key turning point works in action. In early November 2010, Boeing (BA) gapped down and made a straight-line run lower until it found support at 62. The speed of the decline and the support layer that it would slam into made me feel confident that the stock was due to bounce. But how high would it bounce?
FIGURE 2.1 A potential swing trade would have missed its exit price by just 4 cents.
My guess was that the bounce would carry the stock back to the bottom of the gap, stopping at 67.69 (the high the day before the gap). I considered taking a huge position in the stock to boost the profit potential, but decided not to. I paper traded it instead. Why I chose to step aside is hard to explain, but I just did not feel confident that the trade would work as I expected.
Entry would have been at about 63.35 (the open on the day shown), and I would have planned to exit a bit shy of the target, say 67.43 (below the round number 67.50), probably using a limit order.
Since the stock dropped like a stone through water on the way down, I expected (hoped, really) a quick bounce. Instead, the stock seesawed up and down, taking its time as it trended higher. Three weeks later, the stock peaked and reached a high of 67.39, just 4 cents shy of my exit price!
Although that sounds like a near perfect call, it is a lot like throwing horseshoes or hand grenades: closeness counts. Missing by a few pennies would have turned a winning trade into a less profitable one, certainly, and my guess is it would have been much worse.
Since I am an end-of-day trader, the best I could have hoped for would have been an exit at the open the next day, at 66.19. More likely, though, I would have postponed selling for another day, exiting near 65.50. A trade worth $4 per share had turned into one making only about $2. That is still a profit, but it hardly compensates for playing with hand grenades.
I made the right choice to watch this trade from the sidelines. The stock dropped back to 63 in short order and got stuck at 65.
This chapter will give you several tools to help identify those swings in a timely fashion. I will expand the tool count in the later chapters. My favorites are supportandresistance and trendlines.
QUICK REVIEW: SUPPORT AND RESISTANCE
I dedicated Chapter 4 in Trading Basics, the first book of this series, to support and resistance, but the topic is worth a quick review. Table 2.1 shows the percentage of how often the technical features work to stop price movement.
TABLE 2.1 Support and Resistance Summary
DescriptionPercentageHorizontal consolidation regions showing support55%Horizontal consolidation regions showing resistance41%Corrective phase of a measured move up or down stopping power35%Peaks showing resistance34%Valleys showing support33%Gaps showing resistance25%Round number support and resistance22%Gaps showing support20%For example, a horizontal consolidation region (HCR)—which is when price travels horizontally and has either flat tops, flat bottoms, or both—acts as a support area and stops price 55 percent of the time. When it acts as overhead resistance, it is not as effective, stopping price 41 percent of the time.
HCRs top the list for effectiveness. At the bottom of the table are gaps. In candlestick-chart-speak, traders call them rising windows or falling windows, but whatever you call them, they do not work well, showing support or resistance just 20 to 25 percent of the time.
Determining where support and resistance will cause price to reverse is crucial to making money. Buy at support and sell at resistance is one way to swing trade (like the example in Figure 2.1 shows). Another way is to sell short at overhead resistance and cover at support. Since price tends to drop faster than it rises (I described this phenomenon in Trading Basics, Chapter 5; see tip 23), you can make more bucks by shorting than going long. I am not recommending that you short stocks, just making an observation.
For more about determining support and resistance areas (and how to trade using them), refer to discussions of the following points in Trading Basics, Chapter 4.
Price drops faster than it rises.Making money is almost as easy as determining where support and resistance are.TRENDLINE TRADING
I discussed trendlines in Trading Basics, Chapter 3 (in the section “The Truth about Trendlines”), and showed how they can come in handy for buy and hold trading (see also the second book of the series, Fundamental Analysis and Position Trading, Chapter 16, under the heading “Timely Trendline Exits”). They are useful for all types of trading, including swing trading.
Figure 2.2 shows an example of using trendlines to signal entries and exits, drawn on the monthly scale. It is a realistic case from the Ultralife Corp. (ULBI) that I pulled from my database, not an example showing ideal conditions. Let us discuss each trendline one at a time.
FIGURE 2.2 The stock moved nowhere over the period shown, but a swing trader could have made $20 per share. Note: monthly scale.
Trendline 1 connects the bottom of the first price bar with the next minor low. If you were to look at the historical price trend not shown on the left, you would see that the trendline should be steeper, allowing a swing trader to short at a higher price (9.00). For this example though, let us assume it is drawn correctly. When price closes below the trendline, sell short at the open the following month. That would get you into the trade at 6.62.
Trendline 2 connects the first few peaks, but it is clear that price drops faster than the trendline. Another trendline that runs closer to price would give timelier signals. I show that as trendline 3.
Trendline 3 skims along the peaks like a water bug, and it would slice through the price bar at A except for the way I drew it. Since A does not close above the trendline, I redrew trendline 3 so that it just touches the top at A. Either way, the trendline gives the same trading signal. When price closes above the trendline, cover the short position at the open the next month at 3.71.
Price trends higher, leading to trendline 4. This is an unusually steep trendline, and steep ones often do not last long. This case is an exception. It lasts over a year as the stock climbs into the clouds. This one trade represents the majority of the profits from swing trading this stock: over $16 per share. Price closes below the trendline, signaling an exit at the next price bar at the open.
Trendline 5 has many top touches, so it is well constructed. It follows price downward, and although the drop does not look like much, it is over 7 points due to the log scale I use on the chart.
Price rises and slices through trendline 5, closing out the short trade. Trendline 6 begins by connecting the price bottoms, and here is where things go bad. Entry occurs at 12.74, the month after price closes above trendline 5. Where does the sale occur?
When price closes below trendline 6, sell the long position at the next bar. That occurs at 11.59 for a loss of $1.15 per share. You would go short at this point, and that would only compound the problem.
Trendline 7 leads the way lower, but the price bar at B signals an exit to the short and the next price bar does not offer much relief when it opens near the same price as the prior bar’s close. This trade is another loser.
Since price has closed above the trendline, we assume a new uptrend has begun, so we go long . . . and price drops instead. This reversal hands us our biggest loss, nearly 7 points. Trendline 8 saves us from disaster by closing out the trade and forcing a short sale.
Trendline 9 rides the stock lower, closing out the short at 4.52, for a gain. Trendline 10 does nothing since price zips upward at a steep angle. Trendline 11 hugs price and will capture more profit than trendline 10 will. Using the closing price on the last price bar gives a gain of 1.74 for that swing.
As I mentioned, the chart uses the monthly scale. Now imagine that it showed not months but minutes. Would the trades change any? In other words, the method of using trendlines as entry and exit signals works on all time scales.
Trendlines work on all time scales.Figure 2.2 shows one example of how traders can profit where investors cannot. By using a simple trendline to signal entry and exits, substantial profits accumulate.
Table 2.2 shows the profit and loss for each swing. If you traded only long positions, you would have made over $10 a share (not including commissions). Short positions would have done a bit better, making $10.42 per share, for a total of $20.48. For buy and hold, the stock opened at 6.13 and closed at 6.26 for a gain of just 13 cents over the nearly 11-year hold time.
TABLE 2.2 Profit and Loss for Trendline Swings
Including commissions and a starting portfolio value of $10,000, the buy and hold value would have inched up to $10,201.86. However, using trendline trades, the investment would have grown to $72,970. This is an example of the power of swing trading over buy and hold.
Trendline Trading Tips
Here is additional help for swing trading using trendlines.
Draw up-sloping trendlines along price valleys (minor lows).Draw down-sloping trendlines along price peaks (minor highs).If price moves too far above an up-sloping trendline (which shows increasing momentum), then draw a new trendline that better hugs price. This will help capture more profit. As a swing trader, learn to adjust your trendlines as necessary, even if they only touch two points.Similarly, if price drops too far below a down-sloping trendline, then redraw it.If price slices through a trendline, moving horizontally (or nearly so), then consider postponing the trade. Price is consolidating, so wait for the breakout. If the breakout is in a favorable direction (upward for up-sloping trendlines and downward for down-sloping trendlines), then do nothing. Redraw the trendline as necessary. An adverse breakout would require a trade to minimize losses.The inset of Figure 2.2 shows this setup. Price climbs following trendline BC. At C, price slices through the trendline, moving horizontally. Selling when price closes to the right of the trendline would be a mistake since price resumes the uptrend.
Price tends to move in a rise-retrace-rise fashion, with price then returning to the retrace area. For those versed in chart patterns, this is a measured move (up or down) pattern with price returning to the corrective phase 35 percent of the time (see Table 2.1). If price moves horizontal in the retrace phase, then expect a measured move.The inset of Figure 2.2 shows an example of this. Price trends upward from B to C and then moves horizontally before resuming the upward move to D. After peaking at D, price returns to the corrective phase C, at E.
Steep trendlines tend to be shorter than shallower ones, so expect a quick exit signal.Practice drawing trendlines using historical data. My computer allows me to draw trendlines and scroll the chart to the left to see how well they play out. I can practice in a stock I am interested in trading using trendlines. If your chart does not have a horizontal scrollbar, then print the chart out and use a piece of paper to cover up the right side. Move the chart to the left, slowly uncovering new price action to see how well the trade progressed as you draw the trendlines. If you are serious about trading with trendlines, then you will do this exercise to practice and become familiar with how the stock behaves.If price closes below an up-sloping trendline or above a down-sloping one, it does not mean a trend change. However, for a swing trader, consider it a trading signal.The time scale you choose to trade should not change the trendline tactics.For the historical price behavior in the security you intend to trade, look for long moves up and down, not horizontal ones. You do not make money if the stock stays pegged near the same price for long.Figure 2.3 shows an example of this horizontal price movement on a weekly scale. Price moves up on the left of the chart in a series of straight-line runs, and then begins to move horizontally, bobbing up and down like a piece of wood riding the waves on a lake. This choppy up and down action is not long enough to make profitable trendline trades. A better strategy is to range trade the boxed area. Buy near the low about 22 and sell near the high, about 25. That is a $3 range, but you may be able to capture only half that.
FIGURE 2.3 Price moves horizontally in a trading range (boxed area), making profitable trendline trades difficult to achieve. Weekly scale.
When price peaks or bottoms, the turn can be messy as in this case of a top. Price moves sideways, battling with the bulls and bears, trying to decide which way to trend. Until traders decide, look elsewhere for a better trading opportunity. Also notice that once price makes up its mind to trend, it does so with force, shooting downward in a straight-line run that sees price tumble below 8.
Combine trendlines with support and resistance areas, such as horizontal consolidation regions or prior peaks and valleys, for a better idea of what price will do. Expect price to reverse at support and resistance.Begin drawing a trendline at the bar after a tall or unusual price spike. Doing so often results in better alignment and better trading signals.If a substantial move occurs (like a one-week drop of 25 percent), then expect the move to continue after a pause, especially if it is a bear market.Draw a vertical line from a recent peak or valley and imagine price reflected around that peak or valley. These price mirrors may help you determine what price will do in the future.As with any trading system, some trades will be profitable and some will not. Practice using trendlines before making any trades, especially when applying them to a security that you have not traded before. Try switching to other time scales to see what they show before making a trading decision.
For example, if price is closing in on a trendline using the weekly scale, switch to the daily chart for better timing of the exit. Look for nearby support or resistance areas where price might reverse.
Draw parallel trendlines (channels) to help gauge where price is going to change trend.
TRADING USING CHANNELS
Speaking of channels, let us discuss them. (In Trading Basics, Chapter 5, I include a section on how to draw three-point channels.) Let us take channels a bit further and trade using them.
Figure 2.4 shows a three-point channel, ABC, drawn on the daily price chart for United Parcel Service (UPS). Draw line CE parallel to line AF. I could lie and say I chose point C because long price spikes (point D) are often unreliable trendline starting points—which they are—but the real reason is that the trendline touches point E if I start it at C and not D.
FIGURE 2.4 A price channel highlights up and down price swings.
For a trend trader, the channel provides a unique timing mechanism. When price touches the trendline at E, it hits support, signaling a buy. At F, it is time to sell when price again bumps up against the top trendline.
Notice that the channel slopes upward. When that is the case, trade from the long side. Short the stocks that use a down-sloping channel. Never do the reverse—go long in a down-sloping channel or short an up-sloping one. The reason is that profits will be squeezed like garlic in a press even if you can call the turns properly.
Before trading a channel, measure the potential profit. It will be an approximation, of course, but it will give you some idea whether the reward is worth the risk. This is especially true of horizontal channels (rectangles). The height of the rectangle can mean the difference between retiring at 36, as I did, and working well into your senior years.
For an up-sloping channel, placing a 5 percent stop loss below the bottom channel line can help prevent a massive loss. It will not stop every loss (as in the case when price gaps lower), but it should limit them. Limiting losses in swing trading is paramount to keeping the risk-to-reward ratio high.
When price nears the top of the channel, be prepared to exit. If price approaches the channel line and then goes horizontal, consider exiting. This is different from a trendline trade where you wait for the breakout from the congestion region. With channel trading, the channel is a support or resistance area, and price is telling you that it has lost momentum. Frequently, that means it is going to reverse. Take the hint and close out the trade. Check the historical price record to verify that this is true for the stock you are trading.
A channel touch is also a timely trading signal. Be aware that price sometimes does not make it up to the channel before reversing.
Figure 2.4 shows an example of that at G (and notice how it appears rounded, signaling a loss of upward momentum). Price at G climbs toward the top channel line, but reaches only the price level of B. It forms a 2B chart pattern (see tip 1 in Chapter 5 of Trading Basics, Timing the Exit: The 2B Rule) and reverses, eventually digging its way to E before finally making a determined effort to reach the top channel line.
When I channel trade, I use any hesitation near the channel line as a clue to exit. Up-sloping channels are more forgiving in this manner because price has a tendency to rise over time (just look at the Dow Industrials from the 1920s until now).
If you miss selling near the channel line, you can wait for another attempt. That is not always the best choice, of course. Learning to sell and sell promptly can make the difference between a successful swing trader and someone who is, well, unsuccessful.
Trade up-sloping channels from the long side.Trade down-sloping channels from the short side.Measure the height (risk versus reward) of the channel before taking a position.Do not expect price to touch the channel line before reversing. Exit the position if price hesitates (flattens or moves horizontally) near the channel line.Look for nearby support or resistance to help gauge where price is going to reverse.Eventually, price breaks out of all channels, so have stops ready to limit any adverse move.THE THREE-BAR NET LINE SETUP
An interview with Joseph Stowell (July 1995) explained a chart pattern called the three-bar net line that he uses to uncover the intermediate-term trend in the bond market. I will explain it, test it, and then show how to use it to trade stocks.
Figure 2.5 shows an example of the three-bar net line for up and down trends (inset) and an example. Let us discuss the pattern in uptrends first. If price is trending upward, find the highest high, which I show as point 1. Follow four rules for each uptrend or downtrend.
FIGURE 2.5 Shown is the three-bar net line for up and down trends (insets) along with a trading example.
For downtrends, reverse the setup.
Testing the Three-Bar Net Line
How well does it work as a trading system for exchange-traded funds (ETFs) or stocks? I programmed my computer to find the three-bar net line and used the following rules or parameters.
$10,000 invested in each trade.554 stocks, including AIG (which fell from the heavens and buried itself).88 long-only ETFs.March 12, 2001, to October 1, 2010, but not all securities covered the entire period.Commissions: $10 per trade.Minimum price of $5 for each security at buy time.The period chosen shows the Standard & Poor’s S&P 500 index ending near where it began, having moved from bear market to bull market twice. I made no allowance for slippage or other fees.
Additionally, the table presents results using the following measurements.
Average gain/loss. This is the per-trade average gain or loss, expressed as a percentage.Average hold time. This is the average trade duration.Average max hold time loss. The hold time loss is how far below the buy price the security drops during the trade. I find the maximum drop for each trade and average the results of all trades. If price did not drop below the buy price, zero is used. This is a measure of the average risk per trade.Win/loss. This is the ratio of winning trades to all trades, expressed as a percentage.S&P 500 index. This is how the index faired for the duration of each trade, averaged over all trades.Table 2.3 shows the results for stocks and ETFs with and without a simple moving average (SMA). Your eye will probably drop to the ETF row where it loses 0.2 percent or $15.85 per trade. Adding in a 50-day simple moving average returns the system to profitability.
TABLE 2.3 Tests on the Three-Bar Net Line
Why add a moving average? Doing so helps remove unprofitable trades in bear markets, so that is why I added it and that is why it improves results.
I also tested this using weekly data (see the 10-week SMA rows). For both stocks and ETFs, the average gain increases substantially, but so does the hold time loss. You make more money, but you stand to lose more, too.
To my knowledge, Stowell did not propose the three-bar net line as a trading system. In fact, he uses it to determine changes in trend on the monthly stock chart along with his cup and cap system. I did not test the three-bar net line using monthly data.
The three-bar net line works well for longer time scales, but the hold time loss increases.Three-Bar Net Line Example
Figure 2.5 shows an example of combining a trendline trade with the three-bar net line. I connected peaks D and E and extended the trendline lower until it intersected price at A. Looking back, point B is the lowest low in the recent downtrend, so that is where we will start looking for the three-bar net line in a downtrend.
Point C is the third bar with an equal or higher high to the left of B, including the high at B. A line drawn to the right of C becomes the buy line when price closes above it. That happens at A, right where the trendline also pierces the price bar. A confirmed trade signals and you would buy at the open the next day.
In this example, the trendline also signals a buy the next day.
Let us assume that you buy the stock and then price makes a substantial move up. You are looking to protect your profit so you draw another trendline connecting the lows at F and G. Price closes below the trendline at H, tentatively signaling a sale.
The three-bar net line should confirm the sale. Point I is the highest high in the recent up trend, so we use the low of that candle and find two equal or lower lows. That takes us back to candle G. A line drawn to the right of this low is the sell line. A close below this line would signal a sale. That does not happen, so you remain in the trade.
The Monsanto Trade
The Monsanto trade uses a modified three-bar net line exit that I will discuss in a moment. Figure 2.6 shows the swing trade, based on an ugly double bottom chart pattern. The start of the ugly double bottom is not shown in the figure but it begins on July 7, 2010, and ends on October 5 (shown), the lowest low on the figure.
FIGURE 2.6 Two buys in this swing trade turn profitable when price advances.
I bought the stock two days after the breakout, at A. Usually, I wait for price to close above the breakout price and buy at the open the next day. This trade has an additional day’s wait that my notes do not explain.
I calculated a volatility stop at 57.93 but chose to place it above the round number of 58, at 58.07. That is below what I called a shelf or congestion zone, which I circled at E.
For the target, I was looking at 70 (bottom of a cloudbank) and then 88 (start of a Big W chart pattern) as locations of overhead resistance.
I scored the chart pattern using the generic scoring system (see Chapter 20,“Ten Factors Make Chart Patterns Work,” in Fundamental Analysis and Position Trading) and found that it had a –1 score with a 78.27 target. The target is based on the median rise of chart patterns. The system said that it would be difficult for the stock to climb that high. That prediction turned out to be right since the stock dropped more than 20 percent (a trend change) before peaking at 78.71 about a year later.
I counted other stocks in the industry and found that 11 of 12 were trending higher, along with the overall market. The stock was in a stage 2 advance (see Chapter 16 in Fundamental Analysis and Position Trading under the heading “The Weinstein Setup”), and earnings were set for early January.
Finally, I noted that “70 should be easy.”
It was not easy because the stock dropped after I bought. On November 17, I wrote in my notebook, “I removed the stop because world events are taking the market lower, potentially allowing the stock to be stopped out. I don’t think this is going to fall far (not below 40), so I think I can hold until it recovers from any drop.”
In fact, I doubled my position that same day, noting, “I am going to buy more because this has thrown back to (E) the tight congestion area (buy at support). With an ugly double bottom in place, I think this is a low risk, high probability win scenario. Sell at 70.”
When price climbed above the 70 sell target, I placed a stop based on the three-bar net line, only I started counting at the day after D (which is the day I placed the stop). Counting back three candles gets me to C. I placed the stop a penny below the candle’s low, at 71.68.
On January 19, I was cashed out a penny below the stop, at C. Using the correct placement of the three-bar net line would have meant a lower stop, costing me money in this trade.
On the swing trade, I made 15 percent on the first entry and 20 percent on the second, including a dividend payment, with a hold time of just over two months. After selling, the stock went horizontal for over a year, suggesting that selling when I did was the right move.
The Guppy Variation
Daryl Guppy (September 1999) has a variation of the three-bar net line that he shared with readers in a magazine article. When searching for the three price bars, he only allows higher highs or lower lows, and ignores price bars of equal value. Figure 2.7 shows an example of this.
FIGURE 2.7 The count-back line acts as an entry trigger.
When price closes above the down-sloping trendline, it is a trading signal. The three-bar net line must confirm the entry before buying the stock. Begin with the lowest recent low, which is point A. The high of that candle is point 1. The prior candle has a higher high, which becomes point 2. The next higher high is at candle B, which ends the sequence. In the search for a higher high, Guppy does not allow ties like Stowell does. A line drawn from the right at B is called the count-back line, which I show as CBL 1.
When price closes above CBL 1, it is the buy signal. That occurs at candle D, so entry occurs the next day, at the open of candle C.
Set a stop loss using the same procedure for finding the three-bar net line, only in reverse. Begin with the day price signaled an entry, D. The low of this candle is point 1. The low of the prior candle is lower, so that becomes point 2, and point 3 is the lower prior low, which is candle A. The low at candle A is the stop loss price for this trade.
The next entry price will trigger when the stop loss price rises above the count-back line. The stop loss is three lower lows away from the current candle (including the current candle). If the current candle is to the right of E, the low of that candle is point 1 and the prior two candles show lower lows, giving points 2 and 3, which I show as Stop 2. The low at Stop 2 is the first candle above the count-back line, so you would buy at the open the day after E. I show that as Buy 2.
Guppy handles the next entry differently. Take the percentage difference between the high at B (the first count-back line) and the pivot low at A, and add it to the high at B to get the maximum chase level. I show that just above C. The next stop loss has to be above the maximum chase level. When price rises to the candle on the right of F, three lower lows bottom at Stop 3. Stop 3 is above the maximum chase level, so buy at the open the next day. I show that as Buy 3.
The Guppy variation of the three-bar net line and his implementation of scaling in provides a methodical way of increasing the position size.Step Summary
For all entries after the third buy, the stop loss has to rise above the high at the prior entry signal day. In this example, candle F is the entry signal day, so the next stop loss has to rise above the high at F before signaling a purchase. Here is a summary of the steps.
Your trading setup signals a trade. In this case, I use a trendline pierce, but it could be a moving average crossover scheme or other trading setup.Find the three-bar net line beginning from the pivot low (most recent low). Find three higher highs, including the current candle’s high. The highest high of those candles becomes the count-back line.Buy at the open the day after price closes above the count-back line.Set a stop loss at three lower lows, beginning with the current candle’s low. All stop loss levels use this mechanism. I would also subtract a penny or two from the third candle’s low because candles will often bottom at the same price before rising again. You do not want to be stopped out if that happens.Calculate a new stop loss (three lower lows minus a penny or two) as price makes a new high. When the stop price rises above the count-back line, buy another position.Calculate the maximum chase level by taking the percentage difference between the first count-back line and the swing low. Apply this to the maximum chase level to get the entry price. When the stop loss level rises above the maximum chase level, then buy at the opening price the next day.Set a stop loss as described.
