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DAVE LANDRY
ON SWING TRADING
 DAVE LANDRY
ON SWING TRADING
David Landry
V4. GORDON PUBLISHING GROUP
Los Angeles, CaliforniaCopyright © 2001, TradingMarkets.com
ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in aretrieval system, or transmitted, in any form or by any means, electronic, mechanical,photocopying, recording, or otherwise, without the prior written permission of thepublisher and the authors.
This publication is designed to provide accurate and authoritative information in re-gard to the subject matter covered. It is sold with the understanding that the authorsand the publisher are not engaged in rendering legal, accounting, or other professionalservice.
Authorization to photocopy items for internal or personal use, or for the internal orpersonal use of specific clients, is granted by M. Gordon Publishing Group, Inc., pro-vided that the U.S. $7.00 per page fee is paid directly to M. Gordon Publishing Group,Inc., 1-213-955-5777.
ISBN 1-893756-09-2
Printed in the United States of America
Cover design by Conrad Kalil. Cover photo by Daniel Lincoln/Liaison. The book wastypeset in Palatino by Judy Brown.To Marcy, for believing in meeven when I didn’t believe in myself.CONTENTS
PREFACE xiACKNOWLEDGMENTS xiiiINTRODUCTION 1SECTION ONE THE BASICS OF SWING TRADING 5Chapter 1 DRAWDOWN: THE TRADER’S WORST ENEMY 7Chapter 2 LANDRY’S RULES AND MONEY MANAGEMENT
FOR THE SWING TRADER uChapter 3 TREND QUALIFIERS 17Chapter 4 STOCK SELECTION 29Chapter 5 PULLBACKS 33SECTION TWO MORE SWING TRADING PATTERNS 59Chapter 6 FAKEOUTS AND FALSE MOVES 61
Trend Knockouts 62Double Top Knockout (DT-KO) 68Trend Pivot (False Rally) Pullbacks 75
viiviii Contents
Chapter 7
Chapter 8
BOW TIES
MICRO PATTERNSHigh-Level Micro Double Bottom 93High-Level Micro Cup and Handle 100
SECTION THREE VOLATILITY
Chapter 9
SECTION FOUR
Chapter 10
SECTION FIVE
Chapter 11
SECTION SIXChapter 12
Chapter 13
FINDING EXPLOSIVE MOVES:AN ADVANCED LESSON IN SWING TRADING
MARKET TIMING
MARKET TIMING FOR SWING TRADINGDiscretionary Analysis 125Oscillator Swing System 129TRIN Reversals 133CVR Ii—Modified 138
OPTIONS
A FEW WORDS ABOUT USINGOPTIONS WITH SWING TRADES
PSYCHOLOGYTRADER’S PSYCHOLOGY
LESSONS LEARNED
SECTION SEVEN PUTTING THE PIECES TOGETHER
Chapter 14
Chapter 15
Chapter 16Chapter 17
Chapter 18
NIGHTLY PREPARATION
MORE EXAMPLESMoney-Management Examples 191Trend Qualifiers and Setup Examples 195
MORE THOUGHTSREADY, SET, WAIT!
CLOSING THOUGHTS
109
111
123
125
159
161
165167
173
183185
191
203207
209Contents ix
APPENDIX 211Formulas 211Glossary 212Shorting Stocks: The Art of Playing Both Sides of The Market 220Capturing Trends with the ADX 224PREFACE
T have a confession. I am a trading-method “junkie.” I buy, or at least usedto buy, every book on trading published. When a book would arrive, I’dtake the phone off the hook, pull down the shades and was not to be dis-turbed. Id tear into it like an addict long overdue for a fix. When I’d readthe introduction about how great the book was going to be, I’d feel mypulse quicken as I thought of how much money I’d make applying the con-cepts.
Then, slowly but surely, I’d feel myself let down as none of the promisematerialized. Authors had methods that were extremely complex and dif-ficult to understand. Further, they were purposely vague. And worse,many, at the end of the book, would assure me that if I spent anotherthousand or so on a trading course, then I'd really get the concepts.
When Larry Connors, CEO of TradingMarkets.com and M. Gordon Pub-lishing, approached me to do a book, I told him “Great! I’ve got thesetheories.” After a moment of uncomfortable silence, Larry suggested,“Why don’t you write about exactly what you do in a clear, concise man-ner? After all, this is what you do on the Website and what people havecome to expect from you.”
At this point, it hit me. I was on the verge of writing a book long on the-ory and short on substance. A book not unlike the trading books |loathed.
xi 
xii Preface
I began to think, what type of book would I want to buy? With thatthought in my head, I began writing about my exact techniques I use dayin and day out in my trading and market analysis. These techniques arenot rocket science. If you’re looking for a book with complex magic for-mulas, then you'll surely be disappointed. However, if you’re interestedin a simple, straightforward approach to swing trading, then this book isfor you.ACKNOWLEDGMENTS
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In markets, many often come to the same conclusion through observationand experience. Over the years, I’ve come up with many “discoveries,” onlyto later find out that others have come to the same conclusion years prior. Ihave strived to give credit where credit is due to those that have influencedme. For those of you who have come to similar conclusions and are not rec-ognized, I can assure you, it’s simply an oversight and I apologize.
The following people have had a material impact not only on this bookbut also on me, as well as my life. Words alone cannot thank themenough.
Me being where I am was set off by a chain of events six years ago. Achain of events started by Joe Calandro who convinced me that my re-search was worthy.
To Larry Connors, for teaching me how to think “conceptually correct”when it comes to the markets. Also, for pushing me to excel and forcingme to recognize untapped talent, and for providing me with numerousopportunities.
To Jeff Cooper, for teaching me how to read charts and for showing meyou can make a living trading stocks on a short-term basis. To those ofyou familiar with Jeff’s works, you'll notice his influence throughout thismanual.
To my futures broker, Rob Lingle, for giving me the same respect givento large traders back when I was just getting started.
xii 
xiv Acknowledgments
To Ken Brown for teaching me to approach trading as a business and for making me aprincipal in his firm.
To my parents Anna Marie and Sentive Joseph (S.J.) Landry, for putting up with meand all my endeavors over the years.
To my step-daughter Suzie for making me “daddy.” And to my daughter Isabelle foralways greeting me with a big smile and open arms even on days when I violate myrisk-loss parameters. Both of you bring so much joy to my life.
The following people were instrumental in creating this book. Without them, it wouldnever have happened. First and foremost, to the staff of M. Gordon Publishing espe-cially Danilo Torres and Andy Splichal for their work in getting this book published.Thanks also to my editor Judy Brown of Brown Enterprises and proofreaders JimJohnson, Duke Heberlein, Jason Meyer and Marianne Winfield.
To John Del Gaudio for giving me the perspective of an aspiring, novice trader and fornot letting me gloss over anything. 
 
INTRODUCTION
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Natural ebbs and flows of markets occur over time. Markets often thrust,rest and thrust again. Many times these thrusts can be substantial but, un-fortunately, are short lived. In fact, based on research conducted by hedgefund manager Mark Boucher, 70% of a market’s moves occur in 20% of thetime. The rest of the time, markets consolidate by trading back-and-forth to“digest” their gains. The intermediate-term trader is willing to sit throughthese periods for weeks to months. On the other hand, the nimble swingtrader carefully picks his spots and is able to capture the crux of a market'smove without the excessive risks of longer-term market exposure.
At the other end of the spectrum from the intermediate-term trader is thedaytrader. Daytraders avoid carrying positions overnight for fear of largeadverse market moves. However, as professional trader Jeff Cooperstates, “surprises often happen in the direction of the trend.” I’ll take thisone step further and say that surprises happen in the direction of thetrend over several days. And, by holding positions for two to seven days,substantial market moves can often be captured. The exact reason thatdaytraders do not take positions home—for fear of overnight sur-prises—is the exact reason that I do swing trade. Referring to Figure 1.1of Intel (INTC), notice that the stock had rolled over and had began todowntrend. Also notice that it set up and triggered an entry as a Bow Tie(explained in detail in Chapter 7) the same day they announced (after theclose) that they would have an earnings shortfall. The stock implodesovernight and trades lower over the next seven days.a2 Introduction
FIGURE 1.1
 
 
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tel Corp- Daily 10/02/2000 C=40. 125 “4 AST
 
 
 
 
This is not to say that all positions will lead to huge “surprises” over-night. Like all styles of trading, the results of swing trading are skewed.That is, the majority of the profits come from the minority of the trades.You win some, you lose some and through a consistent approach and ex-ercising strict money management, you position yourself to capture ex-traordinary market moves.
This manual is intended to be a complete treatise on momentum-basedswing trading. It is based on my passion for the markets and over 10years of research and trading. Although J have strived to keep the meth-ods as simple as possible, if you are new to trading, you might want tostudy the glossary found in the Appendix before getting started. Lookingahead, in Section One, I cover the basics of swing trading includingdrawdown, rules and money management, straightforward methods foridentifying trends and pullbacks. After years of searching for the “HolyGrail” of trading, I have returned to these time-proven basics. In fact,90% of my trading and market analysis is based upon the concepts cov-Introduction 3
ered here. In Section Two, I discuss more specific setups for swing trad-ing. These include Fakeouts and False Moves which allow the swingtrader to take advantage of traders who have been knocked out or aretrapped on the wrong side of the market; Bow Ties, which seek to cap-ture a transition in the trend without the pitfalls associated with top andbottom picking; and Micro Patterns, which are smaller, yet quite often ef-fective, versions of classical technical analysis patterns. In Section Three,Volatility, I] show how volatility can be combined with basic and ad-vanced concepts discussed in the manual to capture large moves instocks. In Section Four, Market Timing, I show how to combine the pat-terns, setups and concepts discussed in the manual with the overall mar-ket. I’ll also sMow three swing-trading systems developed for the indexfutures. By implementing these techniques, you will stack the odds inyour favor by trading on the correct side of the market. In Section Five,Options, I will show how the swing trader can used options to help con-trol risks and maximize profits. In Section Six, Psychology, I will discusshow to recognize and avoid the psychological pitfalls associated withtrading. I will also discuss lessons learned through my own experienceand those of others. Finally, in Section Seven, I will tie everything to-gether by discussing nightly preparation, as well as providing numerousexamples and some additional thoughts on swing trading. In the Appen-dix, I provide all the formulas mentioned throughout the manual alongwith a primer on shorting stocks for those new to trading. 
 
SECTION ONE
THE BASICS OFSWING TRADING
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CHAPTER 1
DRAWDOWN: THETRADER’S WORST ENEMY
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You cannot get ahead while you are getting even.
— Dick Armey
All the setups and concepts in this manual, or any trading manual for thatmatter, are completely worthless without following general rules and propermoney management. This can best be demonstrated through the study ofdrawdown.
Drawdown is simply the amount of money you lose trading, expressedas a percentage of your total trading equity. If all your trades were profit-able, you would never experience a drawdown. Drawdown does notmeasure overall performance, only the money lost while achieving thatperformance. Its calculation begins only with a losing trade and contin-ues as long as the account hits new equity lows.
Maximum Drawdown or Peak-to-Trough Drawdown is the largest per-centage drop in your account between equity peaks. In other words, it’show much money you lose until you get back to breakeven. If you beganwith $10,000 and lost $4,000 before getting back to breakeven, your maxi-mum drawdown would be 40%. Keep in mind that no matter how much
 I8 Chapter 1
you are up in your account at any given time—100%, 200%, 300%—a100% drawdown will wipe out your trading account.
Recovering from a drawdown can be extremely difficult and illustrateswhy money management is so important. Those new to trading believethat if they lose 10%, they will be back to breakeven on the first 10%gain. Unfortunately, this is not true. In order to make back a 10% loss,you must make at least 11.11% on your remaining equity. Even worse isthat as the drawdowns deepen, the recovery percentage begins to growgeometrically. For example, a 50% loss requires a 100% return just to getback to break even. This is illustrated in Table 1.1 and Figure 1.1 below. Istrongly urge you to make a copy of these figures and paste them nearyour trading desk.
Professional traders and money mangers are well aware of how difficultit is to recover from drawdowns. Those who succeed long term have theutmost respect for risk. They get on top and stay on top, not by beinggunslingers and taking huge risks, but by controlling risk through propermoney management. Sure, we all like to read about famous traders whoparlay small sums into fortunes, but what these stories fail to mention isthat many such traders, through lack of respect for risk, are eventually
 
wiped out.TABLE 1.1% of Gain% Loss of Required toCapital Recoup Loss10% 11.11%20% 25.00%30% 42.85%40% 66.66%50% 100%60% 150%70% 233%80% 400%90% 900%100%. broke
 
 
 
Notice that as losses (drawdown) increase, the percent gain necessary torecover to breakeven increases at a much faster rate.Drawdown: The Trader's Worst Enemy 9
FIGURE 1.1
 
 
 
o-
“OTs oO MO
 
% of Loss
 
 
Percent loss (drawdown) vs. percent to recover. Notice that the percent to recover (top line)grows at a geometric rate as the percent loss increases. This illustrates the difficulty ofrecovering from a loss and why money management is so important.  
CHAPTER 2
LANDRY’S RULES ANDMONEY MANAGEMENTFOR THE SWING TRADER
 
1. Treat Trading as a Business—Most people wouldn’t dream of startinga business without everything necessary. Yet, many, while trying tobecome a successful trader, cut corners when it comes to equipment.Make sure you create an infrastructure which supports your businesson an ongoing and emergency basis. This includes buying the best
computers, data and charts you can afford.
2. Do Your Homework—In trading you are competing against some ofbrightest minds in the world. Therefore, you must be willing to put in
the necessary hours to be prepared.
3. Manage Yourself—In trading you are responsible for all of your deci-sions. Make sure you are making them with a clear mind. Don’t tradeif you are sick, distracted, during major life events or if you are simply
not prepared.I12 Chapter 2
4. The Trend Is Your Friend—Market moves often last much longer andgo much further than most are willing to admit. Trying to pick topsand bottoms is a loser’s game.
5. Limit Losses—As soon as a position is initiated, you should have aprotective stop right below the recent support (for longs), or above re-cent resistance (for shorts). For purposes of the setups outlined in themanual, this will usually be below the lowest bar of the setup (forlongs) or the highest bar of the setup (for shorts). If this is greater than5% of the stock’s value, risk no more than 5%.
Swing trading often produces many small gains with only an occasionalhome run. Therefore, protective stops must be used on all trades. Gettingcareless on just one trade can erase many winners.
  
Longs
       
Support
ProtectiveStop ProtectiveStop
         
Resistance
 
 
6. No Tickie, No Tradie—Swing trading involves identifying short-termsupport and resistance and where a market will likely re-assert itself. Itis not about fading the market by picking tops and bottoms. There-fore, wait for follow through before attempting to enter a trade.
For instance, suppose a market is in rally mode and begins to sell off,chances are the next move will be a resumption of the original uptrend.However, until that uptrend begins to resume, positions should not beinitiated. For longs, this means waiting for the market to turn back up,and for shorts, it means waiting for the market to turn back down.LLLandry's Rules and Money Management for the Swing Trader 13
 
      
Wrong Correct
SecncyEntry\frren Support
7. Take Partial Profits Quickly—On most swing trades, the profits willbe small and have the potential to quickly erode. Therefore, as soon asyour profits (a) are equal to or greater than your initial risk (b), you shouldlock in half of your profits and move your protective stop on your remainingshares to breakeven (c) (near your original entry).
 
   
 
—
 
    
c)
Entry /7k Profit (a)—# Initial Risk (b)
ProtectiveStop
  
 
 
 
 
 
Locking in half of your profits and moving your stop to breakeven whenyour profits are greater than or equal to your initial risk, will help to gen-erate income for your account. This income will help to pay for the inevi-LL14 Chapter 2
FIGURE 2.1
table small losses associated with swing trading. Further, barringovernight gaps, this gives you, at worst, a breakeven trade and a chanceat a home run on the remaining position. Larry Connors, in Connors OnAdvanced Trading, has dubbed this simple, yet effective, form of moneymanagement “2-for-1 Money Management.” We will walk through sev-eral examples of this concept under Chapter 15, “More Examples.”
8. Take Windfall Profits—As a swing trader, windfall profits are oftenfew and far between. Therefore, you should lock in all or a significantpiece of your profits when parabolic moves occur. After all, largemoves occur as players dog pile onto a market as it becomes obviousto the masses. You've got to ask yourself, once it’s obvious and thelast players are entering the market, who's left to buy?
As an example, notice below in Figure 2.1 that Agilent Technologies (A)had a tremendous one-day gain (a), but all of those gains were erodedover the next few days (b).
 
 
Agilent Technologies-Daily 03/15/2000 C=114.250
 
 
 
 Landry's Rules and Money Management for the Swing Trader
Never, never, never allow the above to happen to you. Not only is thisfinancially debilitating but its also psychologically debilitating.
9.
10.
11.
12,
13.
Trade in Liquid and Active Markets—As swing traders, we are look-ing for an immediate short-term move. We don’t have the luxury ofwaiting around until a large price-move takes place. Therefore, themarkets we trade in must be liquid and active so we can move in andout with ease, and, hopefully, capture short-term fluctuations. Tradingin thin and dull markets can be costly and will likely chew you up, asmost short-term trading profits are small. We'll expand upon this con-cept in Chapter 4, Stock Selection and Section Three, Volatility.
Stack the Odds in Your Favor—In trading, the more pieces of thepuzzle that fit together, the better. This means determining an overallmarket bias (if any), trading the strongest stocks in the strongest sec-tors (or weakest stocks in the weakest sectors for shorts) and combin-ing bigger picture technical patterns and studying the volatility of thestock. We'll expand upon these concepts throughout this manual.
Keep Position Size Within Reason—Swing trading is a game of prob-abilities. You win some, you lose some, and hopefully, through a con-sistent approach, you make money overall. Swing trading is not abouttrying to hit “home runs” by taking excessive risk on any one position.In fact, you should never take a position large enough to have a mate-rial impact on your trading account should—or more likely, when—aprice shock occurs. In general, you should not risk more than 2% ofyour account value on any given trade.
Never Add to a Losing Position!—If you are wrong, then admit itand move on. Averaging down, that is, adding to losing positions is aloser’s game.
Enter the Entire Position at Once—In swing trading we are in themarket for a short period of time and looking for a swift move. Unlikethe longer-term player who has the luxury of building positions overtime and at an average price while waiting for the market to move,the swing trader is looking for an immediate move. In most cases, youshould be looking to lock in profits and tighten stops as the marketmoves in your favor—not add to positions.
If you must pyramid, then do it quickly as the position moves in yourfavor, and make sure it looks like an actual pyramid. In other words,only add to profitable positions and establish your largest position
1516 Chapter 2
first. A 3-2-1 is good ratio for establishing positions. For instance, ifyour position size is 500 shares, then enter 300, then 200, then 100,provided of course, the market is moving in your favor while addingto the position.
14, Remain Consistent—Successful traders find a formula and stick to it.Swing trading is no different. You must find an approach that worksfor you and apply it in a consistent methodical manner. In addition tobeing consistent in your approach, you must also be consistent in yourmoney-management techniques. This involves keeping position sizewithin reason, using initial protective stops, taking profits and trailingstops.
15. When In Doubt, Get Out—In swing trading, we are looking for animmediate short-term move. If the market doesn’t move immediately,then there’s no need to remain in the market—even if you're notstopped out. The longer you are in a market that is not moving inyour favor, the more you are exposing yourself to a potential adversemove. In most cases, you're better off exiting the position and waitingfor the market to set up again. A good rule-of-thumb here is to exitpositions that aren’t profitable within one to two days.
16. Know When to Say When—Be willing to stop trading and re-evaluatethe markets, yourself and your methodologies when you encounter astring of losses. The markets will always be there. Gann said it best:“When you make one to three trades that show losses, whether they be largeor small, something is wrong with you and not the market. Your trend mayhave changed. My rule is to get out and wait. Study the reason for yourlosses. Remember, you will never lose any money by being out of the market.”
17. Re-Read Rule #5! 
 
CHAPTER 3
TREND QUALIFIERS
The trend is your friend.— truest market adage
Most of the methods in this manual involve first identifying stronglytrending markets. In this chapter we will look at how to define a trend.
WHAT IS A TREND?
Quite simply an uptrend is a series of higher prices over time. If a stockwas at $50 per share a month ago and is now trading at $100 per share,it’s obviously in an uptrend. When looking at a bar chart, it is a series ofhigher highs and higher lows.
 
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Highs |
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|
4
4
"~“HigherLows
 
 I18 Chapter 3
A downtrend is quite simply a series of lower prices over time. If a stockwas trading at $100 per share a month ago and is now trading at $50 pershare, then obviously it is in a downtrend. When looking at a bar chart, itis a series of lower highs and lower lows.
 
 
 
MEASURING TREND
ADX
Developed by Welles Wilder, the ADX is used to measure the strength ofa market but not its direction. The higher the reading, the stronger thetrend, regardless of whether it is up or down. The direction of the marketis suggested by two components that make up the ADX: the Positive Di-rectional Movement Index (+DMI) and the Minus Directional MovementIndex (-DMI). In general, an ADX reading of 30 or higher with +DMI >-DMI denotes a strong uptrend. Referring to Figure 3.1 of Veritas Soft-ware, notice at point (a) the ADX reading was greater than 30 and the+DMI was above the -DMI suggesting an uptrend was developing. 
Trend Qualifiers 19
FIGURE 3.1
 
 
 
 
 
Conversely, an ADX reading of 30 or higher with -DMI > +DMI denotesa strong downtrend. Referring to Figure 3.2 of Metricom, notice that atpoint (a) the ADX was greater than 30 and the ~-DMI > +DMI suggestinga strong downtrend was developing. 
20 Chapter 3
FIGURE 3.2
 
 
 
 
Details on how ADX and DMI are calculated are provided in the Appen-dix. For purposes of this manual, all you need to know is that ADX >=30 and +DMI > -DMI suggests an uptrend and ADX >= 30 and -DMI >+DMI suggests a downtrend.
DEVELOPING AN EYE FOR TREND
Many are obsessed with finding exact formulas to define trend. They getcaught up in precise measurements. For instance, they won't trade a mar-ket because the ADX is less than X or the RS isn’t greater than Y. Thetruth is, like trading in general, there are no “exacts” when it comes tomeasuring trend.
This is not to say that trend indicators such as ADX do not have theirplace. These standardized indicators are very useful when running com-puter scans on thousands of stocks. In addition, to those newer to trad-ing, these indicators can help take away some of the guesswork.
 Trend Qualifiers 21
So how should trends be measured? The good news is that determiningtrend does not have to be complex. With a little experience, you'll findthat a simple “eyeballing” of a chart will give you a much better idea ofthe trend than any precise computerized method.
TREND QUALIFIERS
There are certain clues that a trending market will leave behind. I havedubbed these “Trend Qualifiers.” With a little practice, you'll be able toquickly glance at a chart, recognize these patterns and know instinctivelywhether or not a market is in a strong trend.
Base Breakouts—A base breakout is when a wide-range bar that goeshigher occurs after a sideways market movement. When a stock goessideways, it suggests the buyers and the sellers agree on price. When thestock breaks out of this base, the buyers have gained control with thelikelihood that the trend is developing.
 
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I
 a22 Chapter 3
Gaps in the direction of the trend—A gap occurs when a stock opensabove the prior day’s high (a gap higher) or opens below the prior day’slow (a gap lower). When a stock gaps in the direction of the uptrend, itsuggests strong demand for the stock as buyers are bidding up the stockbefore it opens. Note in the diagram below that the lows of the gapdays are also greater than the prior day’s high. This indicates even morestrength.
 
Laps in the direction of the trend—A lap occurs when a stock opensgreater than the prior day’s close but less than the prior day’s high.While not as strong as a gap, a lap in the direction of trend suggests de-mand for the stock.
 LLTrend Qualifiers 23
New Highs—A stock must hit new highs if it is in an uptrend. Atwo-month calendar high (approximately 43 trading days) is a good ruleof thumb to use here.
New Lows-—-A stock must hit new lows if it is in a downtrend. Atwo-month calendar low (approximately 43 trading days) is a good ruleof thumb to use here.
Percentage Moves—how much a stock has risen or fallen over a givenperiod of time. For instance, a stock that goes from $50 to $100 in amonth is up 100%. Obviously, though, it doesn’t take mathematics Ph.D.to determine that stocks making such moves are in uptrends.
Strong Closes—When a stock closes within the top 25% of its range, itsuggests that traders were willing to carry the position overnight. Thisimplies demand for the stock. The more days in a row that this occurs,the stronger the uptrend.
High_
=]
_Top 25%
 
 
Wide-Range Bars (Thrusts) in the direction of the trend—The stock’srange is greater than the prior five days (