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Stocks & Commodities V. 22:2 (58,60-63): Swing Trading With Swing Charts by Teresa Lo CHART PATTERNS

Swing Lo

Swing Trad Swing Trading ing With Swing Charts Here’s how you can Here’s can use use swing swing charts charts as an indispensable tool for all your trading.

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by Teres Teresa a Lo

90 80 late, swing trading has caught the attention of 70 many market partici60 pants. This migration of 50 traders from “day” 40 to“swing” trading has 30 most likely been caused by the severe 20 contraction of price movement in most stocks and stock indexes over the past 10 few years. For example, Amazon (Fig10 January 29, 1999 : Average Average True Range Range $10. 30 9 ure 1) is a typical high-profile Internet 8 7 stock. On January 29, 1999, Amazon’s 6 5 20-day average true range (A TR) was October 31, 2003: 4 Average Averag e True Range $1. 93 $10.30. As of October 31, 2003, the 3 2 value was $1.93. Roughly, this means it 1 April 1999 Oct 1999 Apr 2000 Oct 2000 Apr 2001 Oct 2001 Apr 2002 Oct 2002 Apr 2003 now takes more than a week for Amazon to cover the amount of movement GAINI NG POPULARITY POPULARITY . It takes more than a week for this stock that it used to cover in a single day back FIGURE 1: THE REASON SWING TRADING IS GAINI to cover the amount of movement it used to cover in a single day. during the market frenzy, rendering intraday trading quite a bit less profitable than it used to be. While there seems to be no lack of information offered on bars made lower lows, a downswing would be triggered, the subject of swing trading, the meaning of the term swing while an upswing would be triggered if two consecutive bars is often unclear. Let me provide some ins ight into how to use made higher highs. Dunnigan imposed more conditions, but swing charts as an indispensable tool not only for swing what they all have in common is that swing reversals were trades but also for any type of trading. deemed to have occurred by the appearance of specific price bar combinations; therefore, the same formula could be used across all time frames and markets. The point is driven home BAR-BASED SWING REVERSAL Prior to the widespread use of computers, tw o traders laid the by the title of Dunnigan’s last book, One-Way Formula For groundwork for defining swing based on the actual price Trading In Stocks And Commodities, written shortly before action observed in the markets. On e name that will forever be his death in 1957. associated with swing charts is W.D. Gann. In the same era, technician William Dunnigan conducted research into the PERCENTAGE-BASED SWING REVERSAL nature of trends and reversals, but did not construct swing Today, traders tend to use the zigzag indicator or point & charts per se. In recent years, the late Robert Krausz (author, figure charts to create charts with swings. The Japanese trader, and S TOCKS & COMMODITIES contributor) imple- equivalent to zigzag is the line break chart, while renko and mented what is thought to be an alteration that Gann made to kagi charts are the candlestick equivalents to point & figure the method. charts. What these have in common is that tha t the user is prompted What these traders did was make specific rules about what to select an amount or percentage that price must reverse in constitutes an important price reversal. In doing so, they also order for the chart to plot a swing sw ing reversal — the user is the one on e defined a swing. For Gann and Krausz, if two consecutive who defines how far price must mus t go in the opposite direction in

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Stocks & Commodities V. 22:2 (58,60-63): Swing Trading With Swing Charts by Teresa Lo

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FIGURE 2: UPSWINGS AND DOWNSWINGS. The upswings and downswings are connected together. This helps eliminate some noise from the price bars, and helps to visually identify chart patterns and support/resistance points.

order for the move to be deemed significant. Is a 2% price reversal significant, or should it be 5% or 10%? Can the figure be used in all markets and time frames? Suddenly, problems associated with variable parameters — the need for backtesting and optimization — seen in most mathematically computed indicators become major issues.

THE CHALLENGE In 1998, one of my coworkers challenged me to define what I knew about price action in terms that a computer co uld understand. We were preparing to launch a website (Trendvue.com) at the time, and eventually, we managed to define one condition after the next, one trade setup after another. What was once a totally discretionary style evolved into a highly methodical, even mechanical approach with the addition of swing charts to our toolbox. Because the way market participants react to price action and news has not changed over time, we continue to trade the same conditions and setups, namely retracements in a trending market (flags, pennants, classic flags, A BC corrections, wedges), tests of tops or bottoms in a trending market, breakouts or fakeouts of large patterns (triangles and head & shoulders), and spikes (after extreme directional moves).

EYES ON THE ROAD, NOT THE DASHBOARD Over the years, we have continued to use a handful of indicators such as average true range (A TR), average directional index (ADX), and moving averages (MA). We regard these as functional equivalents of dashboard instruments in a car, such as the speedometer and tachometer. Price bars and swings form chart patterns that are akin to moving objects and traffic lights seen through the windshield as we drive. They remain the overriding determinants of how we navigate the road of price action safely year after year. In fact, with information collected over time, we have even made conceptual roadmaps of chart patterns typically

associated with reactions to sets of events that tend to repeat as themes in the market.

SWING THEORY Both bar reversal and percentage reversal swing charts help traders objectively define uptrends and downtrends based on the relative position of adjacent swing highs and swing lows. A series of lower swing highs and lower swing lows constitutes a downtrend. A series of higher swing highs and higher swing lows constitutes an uptrend. When successive upswings and downswings overlap each other significantly, then you know that price action is congested. The advantage of bar-based swing reversals is that the logic naturally extends to cover the price bars within each swing, finally defining a swing. In principle, successive bars with higher lows and higher highs should all be part of a single upswing, while successive bars with lower highs and lower lows should all be part of a single downswing (Figure 2). Gann, Krausz, and Dunnigan all made minor modifications to accommodate some variation, but the concept remains central to swing theory.

CLASSIC PATTERNS AS TRADE SETUPS Our trade setups are based on classic patterns documented long ago by the likes of Richard Schabacker, Robert Edwards, and John Magee. Swings allow you to establish a premise for a trade, and subsequent price action helps make conditional statements to systematically eliminate the range of possible outcomes along the decision tree, providing insight into appropriate exit strategies. These setups help to do a number of things. You may: ■

Identify pivots , major support and resistance points where price reverses to form swing highs and swing lows.

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Identify the structure of a price move based on the relationship between successive upswings and downswings. If a number of higher swing lows are followed by higher swing highs, you can infer an uptrend. If there are a number of lower swing highs and lower swing lows, you can infer a downtrend.

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Identify and differentially diagnose congestion patterns in order to avoid choppy markets. If successive upswings and downswings overlap each other by a significant amount, you know that there is congestion, so you delineate chop zones and mark out large potential breakout patterns.

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Identify and differentially diagnose retracement and test patterns based on the relative positions of the swing pivots in order to enter and exit in a timely fashion.



(SMH) Semiconductor HOLDRS LAST-Daily C=29.950 50SMA 26.442 20EMA 28.109 tvSwing

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FIGURE 3: SWI NG CHARTS IN ACTION. The swing high of 5/12/03 is used as a support level for the pullback. If prices hit this support level you might consider opening a long position.

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SWING CHARTS IN ACTION In the following case study, you can see how to use information obtained from the classic swing chart to analyze price action and how that information can be used to formulate strategy and tactics to set up a trade. S MH Daily Chart, 6/3/03 (Figure 3) Observation: Pullback after a new high to the 5/12/03 swing high. Premise: Potential one-swing bull flag retracement pattern, first bar after the 6/2/03 swing high. Conditional statement: If this is still in an uptrend, then a pullback into the 5/12/03 swing high should find buyers in the $28.93 area and be confirmed as support. Trade setup: Look for ways to enter on the buy side with the 6/2/03 swing high at $30.45 as the initial upside target, since you know that’s where sellers showed up before. S MH Daily Chart, 6/6/03 (Figure 4) Result: Buyers came out as support was confirmed. T he upside target was hit, with continuation. S MH Daily Chart, 10/20/03 (Figure 5) Observation: Pullback after new high to a zone between the 9/8/03 swing high of $38.85 and the 9/17/03 swing high of $38.15. Premise: Potential one-swing bull flag retracement pa ttern, third bar from 10/15/03 swing high. Conditional statement: If this is a new leg up, then a pullback into the zone between $38.15 and $38.85 should find buyers and be confirmed as support. Trade setup: Look to enter on the buy side.

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FIGURE 4: SWING HIGH AS RESISTANCE LEVEL. The swing high of 6/2/03 is your initial upside target. This target was hit and prices continued further.

S MH Daily Chart, 10/22/03 (Figure 6) Observation: Moved up for one day on 10/22/03 but came back down the next. Premise: 10/22/03 becomes a potential lower swing high, but with prices still above the support zone between $38.15 and $38.85, there are several possibilities: 1 A pennant pattern (lower swing high, higher swing low), a larger retracement pattern, will form above the support zone and the moving averages. 2 The lower high might trigger selling by those who assume that it is a reversal signal, and look for a move back down to the support zone and to test the 10/20/ 03 swing low of $38.08 to see if buyers are still there. 3 If the 10/20/03 swing low is taken out by a little bit but price manages to hold above the most commonly used moving averages, the 20-day EMA (in red) and the 50-day MA (in gray), it sets up the two-swing classic bull flag (lower swing high, lower swing low). Conditional statement: While the one-swing bull flag did not hit the upside target in one clean swing, the

Because the way market participants react to price a cti on and news has not changed over time, we continue to trade the same conditions and setups.



Semi conductor HOLDRS LAST-Dai ly C=39.250 50SMA 36.396 20EMA 37.706 tvSwing

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potential lower swing high is still part of two larger retracement patterns. Keep this in mind before you conclude that a reversal is in place.

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Trade setup: Pennant or two-swing classic bull flag.

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S MH Daily Chart, 10/24/03 (Figure 7)

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Observation: The downswing reaches the 10/20/03 swing low, which happens to be the low end of the support zone and the 20-day E MA. You can now eliminate the possibility of a pennant formation, since there is now a lower swing low in place. If you believe this is a reversal, you will want to see the downswing accelerate as the 10/20/03 swing low is broken. Premise: The two-swing classic bull flag outcome is still possible.

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FIGURE 5: PULLBACK ZONES. This is evident from the bull flag retracement pattern on 10/20/03. This pullback zone is a strong support level if it holds.

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Conditional statement: If this is a classic bull flag, then buyers should show up at the 10/20/03 swing low because this is where they showed up b efore. If this is a true reversal from uptrend to downtrend, the buyers will not show up and it should fall right through.

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Trade setup: Classic bull flag.

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S MH Daily Chart, 11/7/03 (Figure 8)

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Conclusion: The 10/20/03 swing low, the support zone, and the 20-day E MA holds on the pullback. The twoswing classic bull flag hits target 1 (10/21/03 swing high) and target 2 (10/15/03 swing high) and goes on for some upside bonus.

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FIGURE 6: DID THE SUPP ORT ZONE HOLD? Prices did move above the support zone, but retraced back just above the support level. This price movement has to be monitored closely.

CONCLUSION Swing charts are a simple yet highly effective visual tool that allows traders to instantly gather volumes of information from a chart. From the identification of support and resistance points, to spotting trends and congestion areas, to identifying classic technical patterns, bar-based swings can be used on any time frame for any instrument. Best of all, they supplement a trader’s personal favorite indicators and contribute to successful trading.


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Teresa Lo is the founder and Chief Market Strategist of TrendVue.com. The Classic Swing indicator shown in this article is available free of charge as a plug-in for eSignal Advanced Charting, TradeStation 2000i, and TradeStation 7.

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FIGURE 7: THE FOLLOWING DAY. Prices moved lower to the low end of the support zone, and coincidentally the 20-day EMA, another support area. There is no possibility of a pennant formation, since a lower swing low is evident.



SUGGESTED READING Edwards, Robert D., and John Magee [2001]. Technical Analysis Of Stock Trends, 8th ed., W.H.C. Bassetti, ed. Saint Lucie Press. Krausz, Robert [1997]. A W.D. Gann Treasure Discovered , Geometric Traders Institute. _____ [1999]. “Multiple Time Frame Trading Using Swing Channels,” Technical Analysis of S TOCKS & C OMMODITIES, Volume 17: January. Maccaro, James [2002]. “The Early Chartists: Schabacker, Edwards, Magee,” Working-Money.com: August 6. Schabaker, Richard W., and Donald R. Mack [1997]. Tech-


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nical Analysis And Stock Market Profits: A Course In Forecasting , Financial Times Prentice Hall, reprint.

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FIGURE 8: THE M YSTERY IS SOLVED. The swing low, support zone, and 20-day EMA all hold and prices rise above upside targets 1 and 2. They didn’t stop there.


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