Using Swing Trading Strategies and Technical Analysis when Trading Stocks to Make Consistent Trading Profits
This article is one small part of a series of lessons using Swing Trading Strategies and Technical Analysis developed by WD Gann which are designed to show how anyone can build a profitable Stock or Commodity trading business from scratch.
The lessons are available for you to study here at StockTradingReview.com
Swing charts can be a valuable technical analysis tool in determining the trend of any market or Stock and assisting with entry and exit levels for your trades.
Please follow along on the charts below as we go through this lesson.
Firstly some basic ground rules for those of you who are unfamiliar with swing charts and swing trading.
WD Gann is credited with bringing swing charting methods into prominence may years ago, and he used swing trading extensively along with his forecasting skills to profit from the market.
Please study the first chart below. I have drawn the swings of the market over the bar chart so you can see how a swing chart is drawn.
Source: Incredible Charts – www.incrediblecharts.com.au
The line on a daily swing chart goes up to the highest point of the daily bars each day until a daily low is broken, then goes down to the low of each bar until a daily high is broken. Pretty simple.
An inside day has no effect on the swing chart – the swing line simply stays where it is until a daily high or low is broken.
An outside day affects a swing chart in different ways, depending on the price action of the market.
If the price rallies first, making a new daily high, then falls and makes a new daily low, the swing chart goes to the top of the high bar first and then to the low of the day.
If the price first goes down and breaks a daily low, then rallies to make a new daily high on the same day, the swing chart goes down to the low of the day, then goes up to the high of the day.
An outside day that is with the trend is usually a very good trend continuation signal – traders tried to change the trend of the market early but were overwhelmed by the other market participants.
You can see examples of outside days in the chart above.
Now, lets have a look at how to use this trading method in a Stock.
Looking firstly at the first chart of UNH below, we can see that the Stock is making higher tops and bottoms, therefore the trend is obviously up.
At no stage has there been any reason for a trader to do anything but buy this Stock or trade it in that direction using Derivatives. If you have charting software and would like to follow along with this trade, please do so now.
If you do not have charting software, consider subscribing to Incrediblecharts or you can go to Bigcharts and use their free charting software. If you use Bigcharts, select ‘Java Chart' with the code UNH and you will be able to scroll back and follow the prices as we go through them.
Source: Incredible Charts – www.incrediblecharts.com.au
The fact that this Stock was in an uptrend prior to this area of the chart gives us a clue as to which way the trend is likely to go in the future. Trends usually continue for far longer than most traders think they will.
The 30 day simple moving average (the blue line) will be our final trend filter for determining trend direction – we will not take a trade against the direction of the 30 day moving average.
WD Gann placed major significance on the fact that strongly trending Stocks or Commodities usually had reactions to the main trend of 3 days or less. Therefore, we will define a strong uptrend by the following rules –
- The price bars are predominately above the shorter term (7 day) moving average
- There are more up days than down days – in other words, more blue bars than red bars on our chart
- The reactions to the main trend are 3 days or less
- We need a higher swing high first, then a higher swing low before we can enter an uptrend
Assuming that we are just starting to trade this Stock and it looks promising as a candidate because it has been trending consistently higher for several weeks, how do we find an entry signal using swing trading rules and strategies?
After the 5 day reaction that ended on December 10 (near the bottom left had side of the chart above), the Stock advanced for 4 days up to what could have been a double top.
Because the trend is up, double tops often fail, but many traders think it's the end of the run and naturally sell, often resulting in a 1 or 2 day reaction. As the top is taken out, the majority of these traders will buy back their sold positions, giving additional strength to the uptrend with their buy orders.
This is what happened here – there was a 1 day reaction and then the Stock rallied straight to a new high for the move, indication great strength in the uptrend and possibly short covering as well.
Our buy signal is as soon as price trades 5 cents above the high of the lowest day any the reaction.
Once we are in the position, we place a stop loss order several cents below the swing low formed by the reaction in case the trend fails to continue – if this occurs we will be safely taken out of the trade with a small loss.
The low of the 1 day reaction at $52.55 failed to make it down to the previous swing high at $51.79 (note the horizontal line drawn across from this top), leaving a gap in price of 76 cents.
This subtle signal is often a sign the market is giving us that it is about to start a strong move higher. The sellers failed in their attempt to push the Stock price lower – This means we should BUY!
By taking out the old high and a potential double top within just one trading day, the Stock is telling us that there is a good chance of further gains. If it had taken several days to take out the old high, the risk is that the move higher has a greater probability of failure.
So, we are now in the trade with a stop loss order in place below the swing low. The Stock had another day up, then another 1 day reaction, then rallied to another potential double top, had an inside day and one day down, then to another new high.
The formation of another higher swing low gives us another opportunity to compound our position as soon as the price trades above the high of the low bar (turning our swing chart up again) and then we place our stop loss orders safely a few cents below the higher swing low.
The Stock again left a gap in price between the swing low and the previous swing high and made a double bottom at $55.51 and $55.54 – this is a very powerful continuation signal.
The Stock then rallied for 5 consecutive days. Things are looking great, then suddenly, in one day, the price falls right back down, through the previous swing lows, and stops us out.
This is a problem if we keep our stop loss orders close below the swing lows. For this reason, it pays to back test how far a Stock you are interested in trading usually goes through swing lows before recovering.
Some Stocks will trend well for months, then break a swing low by 20 or 40 cents, only to then continue on with the trend. If a Stock routinely goes 40 cents, we want to put our stop loss orders at least 50 cents below the most recent swing low, so we are not stopped out prematurely. How far below the swings is something you will be able to work out by back testing the Stocks you trade.
By doing your own research and finding how the Stocks you trade usually react around swing lows, you will be able to place your stop loss orders a safe distance below the swings (or above the swing highs in a downtrend) and ride the big moves without being stopped out.
Of course, some Stocks do not lend themselves to swing trading, so just don't use this strategy on those Companies. Use another method more suited to those particular Stocks.
UNH continued to rally after this selloff, making higher swing highs and lows, then breaking the lows occasionally. The 30 day moving average continued to move higher, so the way to trade this Stock was to keep looking for buying opportunities off each of the higher lows within the trend.
This is one of the drawbacks of swing trading – often very good trades will be interrupted by you being stopped out. Then, you have to wait for a higher swing high, then a higher swing low before you can enter again.
While this is annoying, there are many times when a Stock will trend upwards for many weeks and not break a swing low. There are periods when Stocks will trend lower for weeks or months and not break a swing low.
You cannot know beforehand what will happen with any particular trade, so you just have to take them all and roll with the punches as they occur.
Over time, if you are trading Stocks that trend well and don't consistently break swing lows or highs by more than a few cents, you will do very well using this method.
If the Stocks you trade do not trend, this strategy will cost you a lot of money.
Therefore, look for Stocks that trend and trade only those. The Charts below show some more example of strong trends with the swing chart overlayed over the price bars.
Source: These charts were all supplied by Incredible Charts – www.incrediblecharts.com.au
All it takes is a few of good strong trends like those above each year to make a lot of money trading. Unfortunately, many people fight the trend and sell too early or even short sell Stocks that are in strong uptrends, thinking they have picked the top, only to see the Stock continue to rally further immediately.
By the time the buyers are exhausted, these traders have spent their monetary and psychological capital in a futile attempt to pick the top of the market.
Swing charts give us a mechanical indicator to use for entries and exits and take a lot of the guess work out of our trading. Along with the 30 day moving average, it was very hard to argue that the trend was anything but up at any time here by simply looking at the higher tops and bottoms on the chart and the trend of the blue line.
Losses on some trades are inevitable, as we cannot know for sure what the market will do. It only takes one person somewhere in the world to invalidate your perfect trade set-up and send the price of any Stock in the opposite direction to what you were certain was going to happen.
All our analysis can do is alert us to probabilities – there are no certainties in financial markets. This is the hardest thing for most traders to accept. We all hate to be wrong, but that is the nature of the Business.
All we can do is take every trade and see what happens. The better our analysis and our system, the more likely our trades will produce profits.
Every one of us must develop our own system of analysis that we are comfortable with, based on what we learn from other traders, and then we must take every trade that system signals. If we start to second guess our system, we may as well throw it away and just stick with our day job.
Make a decision to develop a system you are happy with, whether it involves the Swing Trading methods I have shown you in this lesson or not, and commit to taking 20 trade set-ups no matter what, firstly on paper until you gain confidence, then if you are making paper profits, using real cash.
Then follow your rules to the letter. This will give you an objective measure of how profitable your system is and whether it is right for you.
If you can enter a trade and hold a position overnight while still being able to sleep, your plan is sound. If not, you may need to reduce the size of your position or adjust your plan is some other way.
The large profits come from identifying a strongly trending market and taking multiple positions with that trend. This naturally involves holding overnight, sometimes for many nights.
We hope this lesson helps you in your understanding of Swing charts and Gann's Swing Trading methods and how to use them. If you have any questions, please email us by using the form on the Contact Page and we will try to answer them for you.
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Readers are advised that these articles and stories are written solely for informational and educational purposes and are not to be construed as an offer to buy or sell Securities. We cannot give you Investment Advice.
We do not recommend particular Stocks, Options, Index's, Funds or any other security of any kind. If particular Securities are mentioned, they are mentioned only for illustrative and educational purposes.
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You must back test everything you learn here to satisfy yourself that it works in the Stocks or other markets you intend trading. We specifically do not guarantee that you will make any money by implementing these trading and investing strategies.
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