Swing Trading For Dummies E-Book

Omar Bassal

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 527

Veröffentlichungsjahr: 2009

Beschreibung

Take advantage of price swings in strongly trending securitiesand pump up your portfolio! Want to know the strategies of successful swing trading? Thisfriendly guide covers the ins and outs of this risky but profitableinvesting approach, explaining all the basics in plain English.You'll see how to use the two investment approaches - technical andfundamental analysis - to indentify promising securities instrongly trending markets. In addition, this guide covers how tocalculate investment returns and, most important, how to manageyour portfolio's risk. * Learn from a highly experienced trader, analyst, and portfoliomanager - the author shares his insider knowledge * Understand often overlooked topics such as money management,journal keeping, and strategy planning - key areas that willlargely determine your success * Focus on the fundamentals - often overlooked by swing traders,fundamental analysis can increase your chance of success * Determine your entry and exit points with technical analysis -read charts, apply indicators, and compare markets * Evaluate companies with fundamental analysis - grasp the basicsof financial statements and the criteria to screen for undervaluedor overvalued stocks * Develop and implement your trading plan - outline what youtrade and how often, decide your risk tolerance, and calculate yourperformance Open the book and find: * The differences among swing trading, day trading, andbuy-and-hold investing * The pros and cons of technical and fundamental analysis * A step-by-step anatomy of a trade * A wealth of charts and screenshots * Real-world examples of swing trading successes * The 10 deadly sins of swing trading - avoid at all costs! * Sample trading plans * Useful resources for navigating data

Leseprobe

Swing Trading For Dummies®

Table of Contents

Introduction

About This Book

Conventions Used in This Book

Foolish Assumptions

How This Book Is Organized

Part I: Getting into the Swing of Things

Part II: Determining Your Entry and Exit Points: Technical Analysis

Part III: Digging Deeper into the Market: Fundamental Analysis

Part IV: Developing and Implementing Your Trading Plan

Part V: The Part of Tens

Icons Used in This Book

Where to Go from Here

Part I: Getting into the Swing of Things

Chapter 1: Swing Trading from A to Z

What Is Swing Trading?

The differences between swing trading and buy-and-hold investing

The differences between swing trading and day trading

What Swing Trading Is to You: Determining Your Time Commitment

Swing trading as your primary source of income

Swing trading to supplement income or improve investment returns

Swing trading just for fun

Sneaking a Peek at the Swing Trader’s Strategic Plan

The “what”: Determining which securities you’ll trade

The “where”: Deciding where you’ll trade

The “when” and the “how”: Choosing your trading style and strategy

Building Your Swing Trading Prowess

Chapter 2: Understanding the Swing Trader’s Two Main Strategies

Strategy and Style: The Swing Trader’s Bio

Two forms of analysis, head to head

Scope approach: Top down or bottom up?

Styles of trading: Discretionary versus mechanical

Wrapping Your Mind around Technical Theory

Understanding how and why technical analysis works

Sizing up the technical advantages and disadvantages

The two main aspects of technical analysis

Appreciating the Value of the Big Picture: Fundamental Theory

Understanding how and why fundamental analysis works

Surveying the fundamental advantages and disadvantages

Looking at catalysts and the great growth/value divide

Chapter 3: Getting Started with Administrative Tasks

Hooking Up with a Broker

Choosing a broker

Opening an account

Selecting Service Providers

Providers to do business with

Providers to avoid

Starting a Trading Journal

Creating a Winning Mindset

Part II: Determining Your Entry and Exit Points: Technical Analysis

Chapter 4: Charting the Market

Nailing Down the Concepts: The Roles of Price and Volume in Charting

Having Fun with Pictures: The Four Main Chart Types

Charts in Action: A Pictorial View of the Security Cycle of Life

The waiting game: Accumulation

The big bang: Expansion

The aftermath: Distribution

The downfall: Contraction

Assessing Trading-Crowd Psychology: Popular Patterns for All Chart Types

The Darvas box: Accumulation in action

Head and shoulders: The top-off

The cup and handle: Your signal to stick around for coffee

Triangles: A fiscal tug of war

Gaps: Your swing trading crystal ball

Letting Special Candlestick Patterns Reveal Trend Changes

Hammer time!

The hanging man (Morbid, I know)

Double vision: Bullish and bearish engulfing patterns

The triple threat: Morning and evening stars

Measuring the Strength of Trends with Trendlines

Uptrend lines: Support for the stubborn bulls

Downtrend lines: Falling resistance

Horizontal lines: Working to both support and resist

Chapter 5: Asking Technical Indicators for Directions

All You Need to Know about Analyzing Indicators Before You Start

You must apply the right type of indicator

Not all price swings are meaningful

Prices don’t reflect volume, so you need to account for it

An indicator’s accuracy isn’t a measure of its value

Two to three indicators are enough

Inputs should always fit your time horizon

Divergences are the strongest signals in technical analysis

Determining Whether a Security Is Trending

Recognizing Major Trending Indicators

The compass of indicators: Directional Movement Index (DMI)

A mean, lean revelation machine: Moving averages

A meeting of the means: MACD

Spotting Major Non-Trending Indicators

Stochastics: A study of change over time

Relative Strength Index (RSI): A comparison of apples and oranges

Combining Technical Indicators with Chart Patterns

Using Technical Indicators to Determine Net Long or Net Short Positioning

Chapter 6: Analyzing Charts to Trade Trends, Ranges, or Both

Trading Trends versus Trading Ranges: A Quick Rundown

Trading on Trends

Finding a strong trend

Knowing when to enter a trend

Managing your risk by setting your exit level

Trading Ranges: Perhaps Stasis Is Bliss?

Finding a security in a strong trading range

Entering on a range and setting your exit level

Comparing Markets to One Another: Intermarket Analysis

Passing the buck: The U.S. dollar

Tracking commodities

Watching how bond price and stock price movements correlate

Putting Securities in a Market Head-to-Head: Relative Strength Analysis

Treating the world as your oyster: The global scope

Holding industry groups to the market standard

Part III: Digging Deeper into the Market: Fundamental Analysis

Chapter 7: Understanding a Company, Inside and Out

Getting Your Hands on a Company’s Financial Statements

What to look for

When to look

Where to look

Assessing a Company’s Financial Statements

Balance sheet

Income statement

Cash flow statement

Not Just Numbers: Qualitative Data

Valuing a Company Based on Data You’ve Gathered

Understanding the two main methods of valuation

Implementing the swing trader’s preferred model

Chapter 8: Finding Companies Based on Their Fundamentals

Seeing the Forest for the Trees: The Top-Down Approach

Sizing up the market

Assessing industry potential

Starting from the Grassroots Level: The Bottom-Up Approach

Using screens to filter information

Assessing your screening results

Deciding Which Approach to Use

Chapter 9: Six Tried-and-True Steps for Analyzing a Company’s Stock

The Six Step Dance: Analyzing a Company

Taking a Company’s Industry into Account

Scoping out markets you’re familiar with

Identifying what type of sector a company is in

Determining a Company’s Financial Stability

Current ratio

Debt to shareholders’ equity ratio

Interest coverage ratio

Looking Back at Historical Earnings and Sales Growth

Understanding Earnings and Sales Expectations

Checking Out the Competition

Valuing a Company’s Shares

Gauging shares’ relative cheapness or expensiveness

Figuring out whether the comparative share-price difference is justified

Part IV: Developing and Implementing Your Trading Plan

Chapter 10: Strengthening Your Defense: Managing Risk

Risk Measurement and Management in a Nutshell

First Things First: Measuring the Riskiness of Stocks before You Buy

Assessing the beta: One security compared to the market

Looking at liquidity: Trade frequency

Sizing up the company: The smaller, the riskier

Avoiding low-priced shares: As simple as it sounds

Limiting Losses at the Individual Stock Level

Figuring out how much you’re willing to lose

Setting your position size

Building a Portfolio with Minimal Risk

Limit all position losses to 7 percent

Diversify your allocations

Combine long and short positions

Planning Your Exit Strategies

Exiting for profitable trades

Exiting based on the passage of time

Exiting based on a stop loss level

Chapter 11: Fine-Tuning Your Entries and Exits

Understanding Market Mechanics

Surveying the Major Order Types

Living life in the fast lane: Market orders

Knowing your boundaries: Limit orders

Calling a halt: Stop orders

Mixing the best of both worlds: Stop limit orders

Placing Orders as a Part-Time Swing Trader

Entering the fray

Exiting to cut your losses

(or make a profit)

Placing Orders if Swing Trading’s Your Full-Time Gig

Considering the best order types for you

Taking advantage of intraday charting to time your entries and exits

Investigating who’s behind the bidding: Nasdaq Level II quotes

Chapter 12: Walking through a Trade, Swing-Style

Step 1: Sizing Up the Market

Looking for short-term trends on the daily chart

Analyzing the weekly chart for longer-term trends

Step 2: Identifying the Top Industry Groups

Step 3: Selecting Promising Candidates

Screening securities

Ranking the filtered securities and assessing chart patterns

Step 4: Determining Position Size

Setting your stop loss level

Limiting your losses to a certain percentage

Step 5: Executing Your Order

Step 6: Recording Your Trade

Step 7: Monitoring Your Shares’ Motion and Exiting When the Time is Right

Step 8: Improving Your Swing Trading Skills

Chapter 13: Evaluating Your Performance

No Additions, No Withdrawals? No Problem!

Comparing Returns over Different Time Periods: Annualizing Returns

Accounting for Deposits and Withdrawals: The Time-Weighted Return Method

Breaking the time period into chunks

Calculating the return for each time period

Chain-linking time period returns to calculate a total return

Comparing Your Returns to an Appropriate Benchmark

Evaluating Your Trading Plan

Part V: The Part of Tens

Chapter 14: Ten Simple Rules for Swing Trading

Trade Your Plan

Follow the Lead of Industry Groups as Well as the Overall Market

Don’t Let Emotions Control Your Trading!

Diversify!

Set Your Risk Level

Set a Profit Target or Technical Exit

Use Limit Orders

Use Stop Loss Orders

Keep a Trading Journal

Have Fun!

Chapter 15: Ten Deadly Sins of Swing Trading

Starting with Too Little Capital

Gambling on Earnings Dates

Speculating on Penny Stocks

Changing Your Trading Destination Midflight

Doubling Down

Swing Trading Option Securities

Thinking You’re Hot Stuff

Concentrating on a Single Sector

Overtrading

Violating Your Trading Plan

Appendix: Resources

Trading ideas: MagicFormulaInvesting.com

Trading software: High Growth Stock Investor

Financial newspaper with stock ideas: Investor’s Business Daily

Charting software: TradeStation

PIMCO’s Bill Gross commentary

Barron’s weekly financial newspaper

Yahoo! Finance portfolio tool

Yahoo! Economic Calendar

Technical Analysis of Stocks & Commodities magazine

The Black Swan: The Impact of the Highly Improbable

Swing Trading For Dummies®

by Omar Bassal, CFA

Swing Trading For Dummies®

Published byWiley Publishing, Inc.111 River St.Hoboken, NJ 07030-5774www.wiley.com

Copyright © 2008 by Wiley Publishing, Inc., Indianapolis, Indiana

Published simultaneously in Canada

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About the Author

Omar Bassal, CFA is the head of Asset Management at NBK Capital, the investment arm of the largest and highest rated bank in the Middle East. There, he oversees all asset management activities for institutional and high net worth individuals investing in the equity markets of the Middle East and North Africa (MENA). Prior to joining NBK Capital, Mr. Bassal was a portfolio manager at Azzad Asset Management, where he managed mutual funds and separately managed accounts. Mr. Bassal also worked as an analyst at Profit Investment Management and launched a socially responsible hedge fund in 2002. He holds an MBA with honors in finance, management, and statistics from the Wharton School of Business at the University of Pennsylvania. Additionally, he graduated summa cum laude with a Bachelor’s of Science degree in Economics, also from the Wharton School. He has appeared on CNBC and has contributed articles to Barron’s and Technical Analysis of Stocks & Commodities.

Dedication

To my mother, my mother, and my mother — Maha Al-Hiraki Bassal. To my father, Dr. Aly Bassal. And my sisters, Suzie and Sarah. To my loving wife, Salma, and my brother-in-law, Hisham. And to my beloved nephew, Mostafa. They have always supported me in easy and difficult times.

Author’s Acknowledgments

I don’t believe any experience could possibly have prepared me for the rigorous schedule required to write a book. I can’t tell you how many weekends, evenings, and holidays were required to write Swing Trading For Dummies. The effort was, of course, worth it. But I did miss several episodes of Lost, The Office, and other shows. Alas, the cost of writing books isn’t measured in time alone.

Before I turn this section into an autobiography (which I should pitch to Wiley as my second book, come to think of it: Omar Bassal For Dummies!), let me thank those who deserve thanks (give credit where credit is due, I’m told, is the way the kids are putting it these days). I first learned of this opportunity through Susan Weiner, CFA — a skilled and professional investment writer. Susan told me about a search Wiley was conducting to find an author for this book. Marilyn Allen, my agent, pitched me to Wiley. I’m honored Wiley offered me the opportunity to write this book. Thank you, Stacy Kennedy, for your confidence in me and your buy-in.

Writing the book, as you may have gleaned from my previous comments, was a grueling, tough process, and Kristin DeMint was an invaluable resource. She was my project editor and made sure the book progressed. She often joked that she knew nothing about swing trading. But her “weakness” was in reality a strength. Not being an expert in the subject meant Kristin could offer helpful comments on what might confuse a novice when I made assumptions or didn’t properly explain ideas. Kristin also kept a watchful eye when deadlines approached. Oh how I didn’t want to draw her ire. (I’m half joking. She’s actually a very sweet person . . . as long as I didn’t miss my deadline!)

As my trading mentor, Ian Woodward, once said: Many hands make light work. In addition to Kristin, many Wiley staff members worked behind the scenes. Russell Rhoads, the technical editor, ensured I wasn’t making things up, and other editors — Todd Lothery, Jennifer Tucci, and Elizabeth Rea — made sure my grammar made cents. (They must’ve missed this part!)

Though not involved directly in my project, per se, my family supported me throughout. That meant a lot. It’s not something I can put into words — even as a writer.

Publisher’s Acknowledgments

We’re proud of this book; please send us your comments through our online registration form located at http://dummies.custhelp.com. For other comments, please contact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax [phone].

Some of the people who helped bring this book to market include the following:

Acquisitions, Editorial, and Media Development

Project Editor: Kristin DeMint

Acquisitions Editor: Stacy Kennedy

Senior Copy Editor: Elizabeth Rea

Copy Editors: Todd Lothery, Jennifer Tucci

Assistant Editor: Erin Calligan Mooney

Technical Editor: Russell Rhoads

Editorial Manager: Michelle Hacker

Editorial Assistants: Joe Niesen, Jennette ElNaggar

Cover Photos: © ACE STOCK LIMITED/ Alamy

Cartoons: Rich Tennant (www.the5thwave.com)

Composition Services

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Publishing and Editorial for Consumer Dummies

Diane Graves Steele, Vice President and Publisher, Consumer Dummies

Kristin Ferguson-Wagstaffe, Product Development Director, Consumer Dummies

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Kelly Regan, Editorial Director, Travel

Publishing for Technology Dummies

Andy Cummings, Vice President and Publisher, Dummies Technology/General User

Composition Services

Gerry Fahey, Vice President of Production Services

Debbie Stailey, Director of Composition Services

Introduction

I wish I could tell you that swing trading is fast and easy and leads to overnight profits that will make you an instant millionaire. Just buy my five CDs today to discover how you can swing trade to massive riches! Or attend one of my training conferences coming soon to a hotel near you: “How I Swing Trade in My Bathing Suit!” (Film cuts to a testimonial from an “actual” client wearing a Hawaiian T-shirt: “I’ve tried the Omar Bassal Swing Trading Technique [this is patented, of course] and I made more than $5,000 on one trade alone!”)

Okay, back to reality. Swing trading isn’t going to lead to overnight wealth. Period. Anyone who tells you different is either lying or has made an incredibly risky trade that turned out positive by the grace of God. You can go to Las Vegas and bet $10,000 on the color black at the roulette table and possibly double your money (your odds are slightly less than 50 percent). But is that a sound plan?

Of course not. And it’s no different when it comes to swing trading.

At best, as a novice swing trader, you’ll produce market returns in line or slightly above the overall market. If you’re really besting the markets, it may be because you’re taking an inordinate amount of risk that may eventually wipe away your account assets. And even as a stellar swing trader, expect to produce returns of 20 percent or possibly 30 percent annually. (If you want quick profits, first make sure you’re an impeccable market timer, and then look into day trading.)

Unlike day traders, swing traders hold positions over several days and sometimes for a few weeks. But similar to day traders, swing traders rely heavily on signals from chart patterns and technical indicators to time their entries and exits from securities. The goal of swing trading is to profit from short but powerful moves on the long side (buying) and short side (selling) of the stock market.

Swing trading also differs from the buy-and-hold approach to investing. Long-term investors may hold a security through periods of weakness that may last several weeks or months, figuring that the tide will eventually turn and their investment thesis will be proven correct. Swing traders don’t care for such poor performance in the near term. If a security’s price is performing poorly, swing traders exit first and ask questions later. They’re nimble and judicious in choosing potential opportunities.

About This Book

In Swing Trading For Dummies, I introduce you to the strategies and techniques of the swing trader. Moreover, I cover topics given short shrift in some trading textbooks — topics that largely determine your swing trading success. For example, whereas many textbooks focus on chart patterns and technical indicators used in buying or shorting stocks, this book goes one step further to cover the importance of money management, journal keeping, and strategy planning. Although these subjects are less glamorous than looking at charts, they’re actually more important — because even exceedingly skilled chart readers will fail if they devise a flawed system, take unnecessary risks, and don’t learn from their mistakes.

Here are some of the subjects this book covers:

Calculating investment returns: This is one of those unglamorous topics, but if you don’t properly calculate your returns, you’ll never know whether you’re doing any better than the overall market. The process is simple if you’re not adding or taking away funds from your account, but the procedure can get more complex if you frequently withdraw or add funds.

Keeping a journal: The word journal seems to be a lot less offensive to people’s sensibilities than diary. A journal is like a trading coach, telling you what you did wrong or right in past trades and helping you to avoid repeating mistakes you made previously. Just knowing the symbol, price, and date of your trades isn’t going to cut it. This book shows you the key features of a valuable trading journal.

Managing your risk: The most important chapter in Swing Trading For Dummies is Chapter 10, where I explain how to manage your portfolio’s risk. As remarkable as this may sound, even if you get everything wrong except your risk management, you can still make a profit. Van K. Tharp, a trading coach, once said that even a totally random entry system can be profitable if your risk management system is sound.

Focusing on fundamentals: This book differs from other swing trading books in its emphasis on the fundamentals of securities. All too often, swing traders pay attention only to the chart and disregard the company behind the chart. You don’t need to spend 20 hours a day analyzing a company’s financial statements — swing traders don’t have that kind of time on their hands. But it’s essential to find out the basics and apply the most important measures in your trading.

Paying attention to the popular (and easy) chart patterns to trade: Dozens of chart patterns appear from time to time in securities’ price patterns, but not all of them are sound or based on investor psychology. That’s why I focus on the tried-and-true chart patterns to give you the critical ones to look for.

Outlining your swing trading plan: A trading plan must outline when you’re in the market and when you’re not. It must detail your criteria for entering and exiting securities. Your plan should also cover what to do when a trade doesn’t work out, as well as how much you risk and how you handle your profits.

Conventions Used in This Book

I use the following conventions to assist you in reading this text:

Bold terms are for emphasis or to highlight text appearing in bullet point format.

Italics are used to identify new terms that you may not be familiar with. I also use italics to highlight a difference between two approaches (for example, higher than the first case).

Monofont is used as text for Web sites.

Charts and figures used in this book have text next to them explaining the essential point the figure conveys. These captions make it easy to skip to different charts and take away the critical point made in each one.

Foolish Assumptions

I made several assumptions about you when I was writing this book. I’m assuming that you

Know how to trade securities online

Plan on trading stocks or exchange traded funds

Have little or no experience swing trading but are well versed in the basics of trading in general

Are able to access and use Internet Web sites that cover research, charting, news, and your portfolio account

Have the will to change your current trading approach

Don’t have an MBA, CFA charter, or CMT designation and need some terms and techniques explained clearly

Aren’t a genius and don’t think of yourself as the character Matt Damon plays in Good Will Hunting

Appreciate humor and popular movie references

If you want to trade other types of securities — like currencies or commodities — you may want to pick up Currency Trading For Dummies by Mark Galant and Brian Dolan, or Commodities For Dummies by Amine Bouchentouf (both published by Wiley).

How This Book Is Organized

This book has five main parts. You may not need to start at Part I and proceed from there. You may be better served beginning at Part II or Part III if you already know the basics of swing trading.

For that reason, I explain the five parts as follows so you can determine which part or parts you need to focus on.

Part I: Getting into the Swing of Things

Swing trading can be a rewarding endeavor for those who have the time and interest in trading securities over the short term. But you need to pack your backpack before you set out on the journey. Part I helps you do just that.This part introduces you to swing trading and provides an overview of the investment landscape. You also discover the brokers that cater to swing trading and the two main trading strategies (fundamental analysis and technical analysis).

Part II: Determining Your Entry and Exit Points: Technical Analysis

Swing traders rely heavily on technical analysis: the art and science of trading securities based on chart patterns and technical indicators. But it’s easy to get lost in the world of technical analysis given how many different chart patterns and indicators exist. When should you use this indicator over that one? Part II explains the ins and outs of technical analysis for everyone from the neophyte to the market expert.

Part III: Digging Deeper into the Market: Fundamental Analysis

Fundamental analysis is given short shrift in most swing trading books, but I introduce you to the important fundamental measures you may be overlooking. Fundamental analysis doesn’t have to be a scary science that only institutions use to their advantage. You, too, can profit from simple fundamental ratios and measures. In this part, I cover the basics of financial statements and the criteria you can use to screen for under- or overvalued stocks.

Part IV: Developing and Implementing Your Trading Plan

Your trading plan is your map in the swing trading world — or your GPS, if you prefer to have directions read to you. Your trading plan outlines what you trade, how often you trade, how many positions you own, and so on. In creating your plan, you must decide how much to risk on each position and when to exit (for a profit or a loss). You also need to know how to calculate your performance so you can tell whether you’re ahead or behind the overall market.

Part V: The Part of Tens

The Part of Tens includes “Ten Simple Rules for Swing Trading.” Stick to these rules and you’re unlikely to make any major mistakes that take you out of the game. But you need to know more than what to do; you must also know what to avoid at all costs. “Ten Deadly Sins of Swing Trading” covers ten “sins” that are sure to lead to subpar performance. Maybe not today or tomorrow, but eventually, these sins will catch up with you.

And what would a book be without an appendix? In this book’s appendix, I recommend several valuable resources you should use to help you with your swing trading.

Icons Used in This Book

I use icons throughout the book to highlight certain points. Here’s what each one means:

This may be somewhat self-explanatory, but the Remember icon references subject matter you should remember when swing trading. Often, the Remember icon highlights a nuance that may not be apparent at first glance.

I don’t use the Warning icon often, but when you see it, take heed. As a swing trader, you must always take action to ensure you’re able to swing trade another day. I use this icon to point out subject matter that, if ignored, can be hazardous to your financial health.

The Trader’s Secret icon signals that the material presented is quite technical in nature. Most often, the technical tidbits are my own personal insights based on experience.

A Tip icon marks advice on making your life easier as a swing trader. If Swing Trading For Dummies were a second grade classroom, this icon would signal my jumping to the end of the fairy tale Goldilocks and the Three Bears and telling you how it ends. The Tip icon cuts through the fluff and tells you exactly what you need to know.

Where to Go from Here

Like all For Dummies books, this book is modular in format. That means you can skip around to different chapters and focus on what’s most relevant to you. Here’s my recommendation on how best to use this book depending on your skill level:

For a newcomer to swing trading: I strongly encourage you to begin with Part I and proceed to Parts II and IV. You can skip Part III if you plan on exclusively using technical analysis in your swing trading.

For the swing trader looking to refine his or her skills: Parts III and IV will likely be of most value to you because you probably already have a good bit of technical analysis under your belt. Help in designing your trading plan, which I cover in Part IV, may be the best way to improve your results. Remember, Chapter 10 is the most important chapter in this book.

For the swing trading expert: You may benefit most by using this book to target specific areas for improvement. The index or table of contents can help you identify which parts of the book to target.

Part I

Getting into the Swing of Things

In this part . . .

If you’re just embarking on your swing trading journey, then this is the part for you. In the next few chapters, I help you figure out how much time you’re willing to devote to swing trading and clue you in to the lingo you need to know. I also introduce you to the rules of the swing trading game, the steps you can take to get ready to play, and some recommended strategies for growing your portfolio into a swing trading success story.

Chapter 1

Swing Trading from A to Z

In This Chapter

Contrasting swing trading with other types of trading

Deciding how much time you want to devote to swing trading

Getting strategic by preparing your trading plan

Avoiding the mistakes that many swing traders make

You can earn a living in this world in many different ways. The most common way is by mastering some skill — such as medicine in the case of physicians, or computers in the case of information technology experts — and exchanging your time for money. The more skilled you are, the higher your compensation. The upside of mastering a skill is clear: You’re relatively safe with regard to income. Of course, there are no guarantees. Your skill may become outdated (I don’t believe that many horse carriage manufacturers are operating today), or your job may be shipped overseas. You also have a maximum earning potential given the maximum hours you can work without exhausting yourself.

But there’s another way to make a living. Swing trading offers you the prospect of earning income based not on the hours you put in but on the quality of your trades. The better you are at trading, the higher your potential profits. Swing trading takes advantage of short-term price movements and seeks to earn a healthy return on money over a short time period.

Swing trading is a good fit for a minority of the population. It involves tremendous amounts of responsibility. You must rely on yourself and can’t be reckless or prone to gambling. If you’re not disciplined, you may end up with no income (or worse).

This book is a guide for those of you interested in swing trading. To understand swing trading, you should understand what it is and what it isn’t.

What Is Swing Trading?

Swing trading is the art and science of profiting from securities’ short-term price movements spanning a few days to a few weeks — one or two months, max. Swing traders can be individuals or institutions such as hedge funds. They’re rarely 100 percent invested in the market at any time. Rather, they wait for low-risk opportunities and attempt to take the lion’s share of a significant move up or down. When the overall market is riding high, they go long (or buy) more often than they go short. When the overall market is weak, they short more often than they buy. And if the market isn’t doing all that much, they sit patiently on the sidelines.

Uncle Sam differentiates between trading time frames

What would a discussion of swing trading be without mentioning our good old friend Uncle Sam? He has a say in your profits and losses because you presumably pay taxes. And he treats profits and losses differently depending on whether you’re a day/swing trader or the buy-and-hold variety.

The factor that determines how you’re taxed is based on your holding period. If you hold a position for 366 days (one year and one day) and then sell it, any profits from that position are taxed at a lower rate than your ordinary income tax rate (which can be as high as 35 percent). Presently, this rate is 15 percent for most people (5 percent for lower-income individuals, as defined by the federal government). However, this rate can change due to tax law changes. The 15 percent tax rate is set to expire at the end of 2010.

Swing traders, of course, are unlikely to qualify for this lower tax rate on positions. Holding periods for swing traders are measured in days, not years. Short-term profits are likely to be taxed at an individual’s ordinary income tax rate.

But there’s an exception. The government provides special tax treatment to people it considers pattern day traders. Pattern day traders must trade four or more round-trip day trades in five consecutive business days. Pattern day traders must also maintain a brokerage account with at least $25,000 worth of equity (cash and stock). The government allows pattern day traders to treat profits and losses as costs of doing business. This means you can categorize home-office expenses as business expenses (and lower your overall tax rate). More important, you can convert capital gains and losses into ordinary gains and losses under the IRS accounting rules.

A swing trader who trades part time may have difficulty convincing the IRS that he or she is a pattern day trader. But if you’re a full-time swing trader, you should be able to take advantage of the special treatment of pattern day traders. Otherwise, expect to pay taxes on profits at your ordinary income tax rate.

However, swing trading in tax-deferred accounts — like in an Individual Retirement Account (IRA) or a 401(k) Plan — takes care of the tax issue. Gains and profits in such accounts aren’t paid until the account holder withdraws the assets (usually at retirement). Because taxes change often and depend on an individual’s situation, I strongly recommend consulting an accountant or tax professional to understand how swing trading will affect your taxes.

Swing trading is different from day trading or buy-and-hold investing. Those types of investors approach the markets differently, trade at different frequencies, and pay attention to different data sources. You must understand these differences so you don’t focus on aspects that are only relevant to long-term investors.

The differences between swing trading and buy-and-hold investing

If you’re a buy-and-hold investor in the mold of Warren Buffett, you care little for price swings. You don’t short because the overall market trend has generally been up. You study, study, and study some more to identify promising candidates that will appreciate over the coming years. Short-term price movements are merely opportunities to pick up securities (or exit them) at prices not reflective of their true value. In fact, buy-and-hold investors tend to have a portfolio turnover rate (the rate at which their entire portfolio is bought and sold in a year) below 30 percent.

Buy-and-hold investing is an admirable practice, and many investors should follow this approach, because it’s not as time-intensive as swing trading and not as difficult (in my opinion). But if you have the work ethic, discipline, and interest in swing trading, you can take advantage of its opportunities to

Generate an income stream: Buy-and-hold investors are generally concerned with wealth preservation or growth. They don’t invest for current income because they sometimes have to wait a long time for an idea to prove correct. Swing trading, on the other hand, can lead to current income.

Time your buys and sells and hold a basket of positions to diversify your risk: The majority of people aren’t interested in closely following their finances and are best served by investing in a basket of domestic and international mutual funds covering stocks, commodities, and other asset classes. Swing traders can hold a few securities across asset classes or sectors and generate higher profits than those who invest passively.

Profit from price declines and excessive euphoria through shorting, which buy-and-hold investors simply can’t replicate: The essence of shorting is that it allows traders to profit from price declines as opposed to price increases. But shorting involves risks not inherent in buying. When you buy a stock, your loss is limited to the amount you trade. Your potential profit is unlimited, but you can only lose what you put into the security. Shorting carries the exact opposite payoff. A stock can go up over 100 percent, but the theoretical maximum amount of profit a short position can make is 100 percent if the security’s price falls to $0.

Although shorting allows you to profit from the decline of a security, the potential losses from shorting are theoretically unlimited, and the potential gains are limited to the amount you short. So if a security jumps up in price by 30 or 40 percent or more, you may end up owing your broker a tremendous amount of dough.

The differences between swing trading and day trading

Opposite the buy-and-hold investor on the trading continuum is the day trader. Day traders don’t hold any positions overnight. Doing so would expose them to the risk of a gap up or down in a security’s price that could wipe out a large part of their account. Instead, they monitor price movements on a minute-by-minute basis and time entries and exits that span hours.

Day traders have the advantage of riding security price movements that can be quite volatile. This requires time-intensive devotion on their part. Near-term price movements can be driven by a major seller or buyer in the market and not by a company’s fundamentals. Hence, day traders concern themselves with investor psychology more than they do with fundamental data. They’re tracking the noise of the market — they want to know whether the noise is getting louder or quieter.

But it’s not all cake and tea for day traders. They trade so often they rack up major commission charges, which makes it that much more difficult to beat the overall market. A $5,000 profit generated from hundreds of trades may net a day trader a significantly reduced amount after commissions and taxes are taken out. This doesn’t include additional costs the day trader must sustain to support his or her activities.

Swing traders also face stiff commissions (versus the buy-and-hold investor), but nothing as severe as the day trader. Because price movements span several days to several weeks, a company’s fundamentals can come into play to a larger degree than they do for the day trader (day-to-day movements are due less to fundamentals and more to short-term supply and demand of shares). Also, the swing trader can generate higher potential profits on single trades because the holding period is longer than the day trader’s holding period.

What Swing Trading Is to You: Determining Your Time Commitment

Getting started in swing trading requires some reflection. Before you rush out to buy that slick PC or set up that brokerage account, you need to think about what kind of swing trader you want to be. (Yes, swing traders come in different shapes and sizes.)

Your first step is to determine just how much time you can commit to swing trading. You may be a full-time trader for a firm, in which case you should consider yourself as trading for a living. Or you may be doing this part time for income with the intention (and hope) of becoming a full-time trader.

Many swing traders have full-time jobs and have little time to devote to trading, so they trade primarily to improve the returns of their investment accounts. Or perhaps they’re already in retirement and swing trade to grow their assets over time. These swing traders watch the market during the day but rely on orders placed outside market hours to enter or exit their positions. And if they trade in tax-deferred accounts, like an Individual Retirement Account, they can ignore the tax issue.

The point is, you can swing trade whether you have a full-time job or not, but you need to make adjustments depending on whether you’re able to watch the market all day. And by the way, watching the market all day long doesn’t necessarily improve your returns. In fact, doing so can lower them if it causes you to overtrade or react to market gyrations.

Swing trading as your primary source of income

If you intend to swing trade as your primary means of generating income, be prepared to spend several months — if not years — gaining experience before you’re able to give up your job and trade from home full time. Swing traders who trade full time devote several hours a day to trading. They research possible trades before, during, and after market hours. And they handle pressure well.

Many traders find that they can’t handle the stress of trading full time. After all, if swing trading is your main source of income, you face a lot of pressure to generate consistent profits. And you may be more tempted to gamble if you encounter a string of losses. What many traders fail to realize is that the correct response to a series of losses isn’t more trading but less trading. Take a step back and evaluate the situation.

Swing trading for a living isn’t difficult in the sense that to excel at it requires some kind of amazing IQ level or insane work ethic. Rather, it requires an incredible amount of self-restraint, discipline, and calm. A swing trader who trades for income must always be unemotional. When things don’t work out, he or she doesn’t try to get even but moves on to another opportunity.

So don’t quit your day job just because you generate impressive profits for a few months. The name of this game is to always have enough capital to come back and play again. If you plan on living off of $5,000 per month, for example, you can’t expect to generate that kind of profit on $30,000 of capital. That would require a monthly gain of 16.67 percent! Some of the best all-time traders in the world topped out at returns of 20 to 25 percent annually over 20 or 30 years.

Swing trading to supplement income or improve investment returns

This category likely applies to the lion’s share of swing traders. Swing trading with an eye on earning additional income or improving the returns on your portfolio is less stressful than swing trading for a living. You still have something to fall back on if you make a mistake, and you can swing trade while holding down a full-time job.

Part-time swing traders often do their analysis when they get home from work and then implement trades the following day. Even though they may not be able to watch the market all the time, they can enter stop loss orders to protect their capital.

If you want to eventually swing trade full time, you should go through this phase first. Over time, you’ll be able to determine how well you’ve done. And if you follow the other recommendations in this book (like keeping a trading journal, which I cover in Chapter 3), you’ll learn from your mistakes and improve your techniques.

Swing trading part time is suitable for those individuals who

Have a full-time job

Can devote a few hours a week to analyzing markets and securities

Have a passion for financial markets and short-term trading

Have the discipline to consistently place stop loss orders

Are achieving subpar returns in their current investment portfolios from a financial advisor or third party

Don’t gamble with their own money and are unlikely to fall prey to doubling down or taking major risks

If you fit these criteria, then part-time swing trading may be for you. When you first start out, I recommend swing trading with just a small portion of your portfolio so any early mistakes don’t prove too costly. Although paper trading can be beneficial, it can’t compare to the emotions you’ll be battling as a swing trader when you put your own money on the line.

Swing trading just for fun

Some swing traders get a rush from buying and selling securities, sometimes profiting and sometimes losing. Their motivation isn’t to provide or supplement current income. Rather, these swing traders do it for the excitement that comes from watching positions they buy and sell move up and down. Of course, this can lead to significant losses if they abandon the rules designed to protect their capital — rules that I outline throughout this book (specifically in Chapter 10).

If you want to swing trade solely for fun, my advice is: don’t. I recommend that you get your kicks at a bowling alley or basketball court. The danger of trading for fun is that you’re using real money with real consequences. You may begin to risk more of your capital to satisfy your need for excitement. If you lose, you may take extreme action to prove yourself right in the end, like putting all your money into one or two securities. By then you’re really in the realm of gambling.

If you insist on trading for fun, at least restrict yourself to a small amount of your assets and never touch your retirement nest egg. Remember that you’re competing with traders who are motivated by profit, not just excitement. That gives them an advantage over someone who just enjoys the game.

Sneaking a Peek at the Swing Trader’s Strategic Plan

Plan your trade and trade your plan.

Fail to plan and you plan to fail.

Countless clichés address the importance of a trading plan. A trading plan is the business plan of your trading business. Without the plan, you’re likely to fall into the trap of making things up as you go. Your trading will be erratic. You won’t improve because you won’t have the records on your past trading. You may think your trading plan is in your head, but if you haven’t written it down, for all intents and purposes it doesn’t exist.

Throughout this book I cover all the important parts of swing trading strategy in detail. In the following sections, I preview the critical parts of the strategy, trimming them all down into one neat little package. (For more on your trading plan, see Chapter 10.)

The “what”: Determining which securities you’ll trade

Your trading plan should identify the securities you trade. As a swing trader, you can choose from a variety of securities:

Public equity (stock): This category is perhaps what you’re most familiar with. Common stocks, American Depository Receipts, and exchange traded funds fall under this rubric. Swing traders often trade stocks exclusively because of the variety, ease, and familiarity of trading corporate stocks. Most stocks listed in the United States trade every day, but stocks in foreign markets may trade infrequently (perhaps once a week). To make your entries and exits as painless as possible, you must focus only on those stocks that meet a specified level of volume. Trying to sell 1,000 shares of a stock that trades 5,000 shares in a day can be extremely costly. I recommend you use stocks due to the abundant information on firms domestically and even internationally.

One of the beauties of stocks is how efficient they are to trade, partly because they offer exposure to other asset classes. For example, you can gain exposure to the commodity gold by trading an exchanged traded fund with underlying assets in gold bullion. I stick to stocks myself because that’s my area of expertise, and I recommend them because of this exposure to other asset classes and because of the variety of positions you can choose from. But you may wish to trade other asset classes as well — that’s your call.

• American Depository Receipts (ADRs): ADRs have become increasingly important in today’s globalized world. Simply put, an ADR allows U.S. investors to buy shares of foreign companies. ADRs are quoted in U.S. dollars and pay dividends in U.S. dollars. Trading ADRs is much more cost efficient than setting up accounts in several foreign countries, converting your dollars into foreign currencies, and so on. And because the economic growth of emerging nations is outstripping the growth of developed countries, ADRs can offer strong profit opportunities. ADRs of companies based in emerging markets (like Brazil or China) are sometimes highly leveraged to a particular commodity, making ADRs one way to profit from commodity price strength.

• Exchange traded funds (ETFs): ETFs are pooled investments. The most common ETFs mirror the movement of an index (such as SPY, a popular ETF that tracks the S&P 500 Index) or a subsector of an index. If you want to ride a coming tech bounce, you may be better served trading a technology ETF than choosing a particular tech company that may or may not follow the overall tech sector. That’s because if you’re right on the move, you’ll profit from a diversified technology ETF. However, a single technology security may buck the trend. ETFs also offer you the ability to profit from international indexes and commodities.

Closed end funds: These funds are basically mutual funds that trade on a secondary exchange. Traditional, open end mutual funds are priced according to their net asset value — or the value left after subtracting the fund’s liabilities from its assets. Closed end funds are different. They’re priced according to the supply and demand for shares of that particular fund. Sometimes, a closed end fund will trade for more than its net asset value; other times, it will trade for less. Closed end funds may be an efficient way to profit from international markets.

Fixed-income markets: These markets include securities issued by governments on the federal, state, and local level, as well as those issued by corporations. The value of fixed-income securities depends on interest rates, inflation, the issuer’s credit worthiness, and other factors. Because the fixed-income market tends to have less volatility than stocks and other asset classes, many swing traders usually avoid trading it.

Futures contracts: Standardized contracts to buy or sell an underlying asset on a certain date in the future at a certain price are known as futures contracts. Futures are traded on commodities and financial instruments, such as equity indexes. Technically, the buyer and seller don’t exchange money until the contract’s expiration. However, futures exchanges require traders to post a margin of 5 percent to 15 percent of the contract’s value. This means that traders can employ extreme leverage, if they choose, by putting down only a small amount of the contract’s value.

I strongly recommend avoiding the use of such extreme leverage because of the potential to lose most, if not all, of your assets due to an unexpected move in a security. Newcomers in particular should avoid using leverage. Even experienced swing traders can become careless or arrogant before the market educates them.

Commodities: This security type is perhaps the biggest asset class receiving attention today other than stocks. With the boom in the prices of everything from gold to crude oil, commodities are attracting more money from swing traders. Commodities — including energy commodities, agricultural commodities, and precious metals — are traded in the futures markets.

You can profit from commodity price movements through stocks or exchange traded funds. For example, swing traders wanting to profit from movements in gold prices can trade streetTRACKS Gold shares, which tracks the movement of gold bullion prices. But trading commodities involves risks and issues that differ from trading equities. (See Commodities For Dummies by Amine Bouchentouf, published by Wiley, for more information on trading commodities.)

The currency market: Often called the foreign exchange market or forex market, the currency market is the largest financial market in the world. According to the Bank of International Settlements, the average daily turnover in the foreign exchange markets is $3.21 trillion. Like the futures market, trading in the currency market allows for extreme leverage.

Not all brokers offer trading in foreign exchange, so make sure you check whether your broker has the capability. Unlike stocks, trading in the currency market is concentrated in a few currencies: the U.S. dollar, the euro, the Japanese yen, the British pound sterling, and the Swiss franc. If you plan on using fundamental analysis to complement your technical analysis as a swing trader (see the definitions of both terms in the section “Establishing your analysis techniques” later in this chapter), be prepared to learn about the various factors that affect the value of foreign currencies: inflation, political stability, government deficits, and economic growth — to name a few. (See Currency Trading For Dummies by Mark Galant and Brian Dolan, published by Wiley, for more information on trading currencies.)

Options: Investment contracts that give the purchaser the option, but not the obligation, to buy an underlying asset at a specified price up until the expiration date are known as options. Options are highly risky and not efficient swing trading vehicles because of their illiquidity.

The “where”: Deciding where you’ll trade

Where you trade depends a great deal on what you trade. Stocks, commodities, currencies, and bonds trade on different markets.

The New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and NASDAQ list stocks based in the United States and abroad (they also list other investment vehicles, like exchange traded funds, that enable you to profit from movements in prices of commodities and other asset classes). The NASDAQ differs from the NYSE and AMEX in that it’s completely electronic and allows for efficient transaction and order routing.

Not all stocks trade on these markets. Recently, electronic communication networks (ECNs) have emerged as an efficient way to match buy and sell orders. ECNs connect individual traders with major brokerage firms. You sometimes can get a better price by submitting orders to an ECN instead of a broker. The easiest way to access ECNs is by subscribing to a broker who provides direct access trading.

But swing traders can buy and sell other securities on other markets. For example, if you want to trade an actual commodity, the Chicago Board of Trade (CBOT) lists several commodities: ethanol, gold, silver, corn, oats, rice, soybeans, and wheat. The New York Mercantile Exchange (NYMEX) also lists popular commodities like crude oil, coal, natural gas, and gold. But you must consider the additional risk factors if you venture outside trading stocks. For example, commodities require different margin requirements than stocks. Not properly employing a risk management system can lead to losing your entire capital on a single trade. Commodities also trade on different fundamentals than companies or fixed-income securities.

If you want to trade commodities, currencies, or other investment vehicles, you need to trade via firms authorized to transact in those markets.

The “when” and the “how”: Choosing your trading style and strategy

Whether you enter orders during or after market hours affects your entry and exit strategies.

Part-time swing traders enter orders when markets are closed and rely on limit and stop losses to execute this strategy.

Full-time traders, on the other hand, can execute their entries and exits during the day and incorporate intraday price action into their timing of trades. They also find more trading opportunities because they have more time to devote to swing trading.

How you trade refers to your various trading strategies, which I outline in this section.

Establishing your analysis techniques

Swing traders rely on two major analysis techniques: technical analysis and fundamental analysis. Technical analysis, broadly speaking, encompasses chart pattern analysis and the application of mathematical formulas to security prices and volume. Fundamental analysis covers earnings, sales, and other fundamentals of a company or a security.

In my experience, most swing traders rely solely or in large measure on technical analysis. However, I explain both analysis techniques in this book because I strongly believe that understanding and using both improves the odds of success.

Both analysis techniques have their advantages:

Technical analysis can be quickly and easily applied to any market or security. For example, a trained swing trader can use technical analysis to quickly decide whether to buy or sell a security using chart patterns of technical indicators. In contrast, a swing trader relying on fundamental analysis needs more time to read about a company, its business, and its earnings before coming to a conclusion. Whether you’re trading commodities, currencies, stocks, or bonds, you can apply technical analysis uniformly to these markets. In other words, if you know how to interpret a chart, then the kind of security being plotted is largely irrelevant. In my opinion, the ease of application is the biggest advantage technical analysis has over fundamental analysis.

Fundamental analysis can answer questions that are beyond the scope of technical analysis, such as, “Why is this security price moving?” Swing trading on the long and short side based, in part, on fundamentals is like having a head start in the 100-meter dash. Rallies and declines that are driven by fundamentals are more profitable to trade than rallies and declines that are simply the result of noise in the markets (such as a large mutual fund liquidating or buying a position). Over the long term, security movements are driven by the securities’ underlying fundamentals. Crude oil prices rise when demand exceeds supply or when supply becomes scarce — not, as technical analysis may superficially indicate, because the chart developed a bullish formation. (Of course, crude oil — or any security — can rise or fall due to non-fundamental reasons. But such rallies and declines are often fleeting and not as strong as fundamentally driven price moves.)

Some swing traders shy away from learning about a company’s fundamentals. Generally, fundamental analysis is seen as long, laborious, and not always right. But you can improve your swing trading by getting to the essence of a company’s fundamentals, even though it does require extensive reading, researching, and modeling.

Just how much should you care about a company’s fundamentals? The general rule of thumb is that the longer your investment horizon, the more important fundamental analysis becomes. The shorter your horizon, the less important fundamental analysis is in trading securities. This is because short-term movements are driven by momentum, noise, and other factors. Over the long term, however, fundamentals always win out.

But just because you understand how to apply fundamentals doesn’t mean you’ll make money. Markets don’t rise simply because they’re undervalued, or fall simply because they’re overvalued. Markets can remain under- or overvalued for long periods of time. That’s why I don’t recommend swing trading on fundamentals alone. Fundamental analysis tells you which way the wind is blowing so you’re prepared, but technical analysis provides the important timing components.

Choosing candidates to buy

You can find promising securities in two main ways — the top-down approach and the bottom-up approach. Both are covered in detail in Chapter 8, but here’s a brief rundown:

Top-down: Swing traders who prefer the top-down approach identify opportunities beginning at the market level, drill down to the industry level, and finally look at individual companies. If you fit this category, your entry strategy should begin with an examination of the overall markets, then trickle down to the major sectors in the market, and then to the industries within the strongest or weakest sectors. At this point, you rank the securities in the industry on some technical or fundamental measure (more on that in Chapter 8). Then you select the securities that meet your entry strategy.

Bottom-up: Swing traders who use the bottom-up approach are grassroots-oriented individuals who look for strong securities and then filter promising ones by their industry groups or sectors. If you fit this category, your approach begins with a screen of some sort (a screen