be tiny. When it all goes wrong, however, andyour intuition is faulty or an unforeseen event overtakes the market, the losses can be large. Ihave never audited my countertrend trading but I am quite sure it has not served me well, apartfrom the charge I’ve got out of ‘beating the market’.In recent years, I have found a middle path. I try never to trade counter to the trend, and on thosefew occasions when I cannot resist the temptation, I trade just one contract, so my bottom lineis hardly affected. It’s pointless, I know, but everyone has their foibles.
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Summation
5. Overweighting the most recent price action
It is a part of Dow theory, and a well-known market saying that the trend continues until it ends.This Zen-like truism is meant to express the durability and tenacity of the prevailing trend. Butparticularly during bouts of irrational exuberance or the sort of vicious falls in the marketswhich took place in June and July 2002, there is tendency for traders, reinforced by mediaheadlines, to overweight the most recent price action, to their ultimate cost. You will hear absurdprojections about how low or how high the market will go. Don’t believe them. Be prepared forchange. The history of the market shows that it unfolds in waves and that every trend has majorcorrections. From the point of view of the long-term buy and hold investor, these majorcorrections, up or down, may well be no more than a blip. But since swing trading is essentiallya short-term activity, usually quite highly leveraged, getting caught by a major correction can beruinous. Once a short-term trend has run for a number of weeks, be sceptical about itscontinuance.
Final wordIt is not really my motive to convert anyone. The best conversions come from within. I hope Ihave given a snapshot of a balanced, logical and methodical way to trade the markets. But Ishould perhaps make a few entreaties:a. If you’ve never tried index trading, give it a go. It is so much easier and less frustratingthan trading individual shares. If you don’t like leverage, try buying and selling ETFs.b. If you’re still unimpressed by swing charts, you are difficult to please. Paper trade themon your main market index, or on the most liquid stock that interests you. If nothing else,forget about trading all the swings as I do. See how trading just the first continuation of trendsignal would have worked.c. Although rules are good, thought is better. Think about what the chart is telling you. Oneof the popular charting web sites (www.futuresource.com) has a fine motto: ‘The market hasspoken: were you listening?’. That should be a mantra for every trader or investor.
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APPENDIX 1Construction of a point & figure chart1.
X’s represent rising prices, O’s represent falling prices. Each X or O represents a unit ofvalue which is chosen by the chartist and can be altered to produce a chart which is moresensitive or less sensitive to price movement.In general, daytraders will use very sensitive charts i.e. those with lowest feasible unitvalue per box. For swing traders, I recommend a minimum box value of 0.5%, and adesirable box value of about 1-2%. Low box values of about 0.5% or slightly higher canbe used for charting equity indices, but in my opinion, box values of at least 1% shouldbe used in the case of individual equities.
2.
The point & figure chart is constructed as a series of columnar reversals. It is possible touse a 1 or 2 box reversal method, but the standard, and the best way is the 3 box reversalmethod. With the 3 box reversal method, no reversal i.e. no new column is ever plotteduntil the reversal has reached the threshold of 3 full boxes.
3.
Each X or O is plotted only when the exact price level has been attained or surpassed.There is no rounding up or down.So in a 5p box chart, where a market advances from 350p to 379p, then falls to 361p, 5additional Xs will be plotted taking the column of Xs up from 350p to 375p, but 380p willnot be plotted because it has not been attained. A 3 box reversal from 375p would beachieved by a fall to 360p, which one would plot by entering 3 Os in the next column.Although the share price has fallen 18p from its highs which seems like more than 3boxes, no reversal is plotted in this case because the 4p between 375p and 379p iseffectively ignored. The market will need to reverse to 360p for the reversal to be plotted.Suppose that the market now trades up from 361p to 377p. No new plot is made. It thentrades down to 363p. Still no new plot is made. These minor oscillations are regarded bythe point & figure chartist as background noise. Finally the share trades down to 358p,before rallying to 376p on the same day. Now a new column of 3 Os will be plotted torecord the print at 360p, and a further new column of 3 Xs will be plotted to record therally from 360p to 375p.The above price action may have taken place all in one day, or spread over two days orspread over a much longer period. It makes no difference to the plotting of the chart.
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4.
Now change the box size to 10p and a different picture emerges. All the chart will showis 2 additional Xs to record the advance from 350p to 370p. Since no 30p reversal hasoccurred, there will be no column of Os until, and unless, 340p prints.
5.
Now change the box size to 3p. The first rally from 350p to 379p will result in 9additional Xs to record the print at 377p. It will be followed by a column of 5 Os to recordthe fall to 362p, then another column 5 Xs to record the rally to 377p, then anothercolumn of 6 Os to record the fall to 359p, and finally a column of 5 Xs to record the rallyto 374p. So the 5p box chart has 3 columns, the 10p box chart has 1 column and the 3pbox chart has 5 columns. The three charts reflect the same price action like this:
3p box
10p box
5p box
375
400
350
350
365
350
fig App 1.1
6.
fig App 1.2
fig App 1.3
Dangers of swing trading based on signals from a point & figure chartconstructed using closing prices only
Suppose that after a long straight decline to 300p, where it closes, a share records thefollowing price movement in the ensuing days.Day 1 - it rallies to 312p, then falls to 298p before closing at 302pDay 2 - it rallies to 313p, then falls to 303p, before closing at 306pDay 3 - it rallies to 340p and closes at 340p192
Appendix 1 - Construction of a point & figure chart
Now construct a 3p x3 point & figure chart. A real-time chart would show a triple top buysignal with rising lows, one of the most powerful signals there is. You would buy at 315pon day 3 and you would be showing a healthy profit.
345
330
315
300
fig App 1.4
A chart constructed with closing prices would show no buy signal at all, only what lookedlike a bear market rally with a single column of Xs rising from 300p to 339p. So thatwould amount to a missed opportunity. But missed opportunities are the least of theproblem. A point & figure chart based on closing prices can positively mislead you intobuying (or selling) at precisely the wrong time.Take the same example as above but change the closing prices to 309p on day 1, 300p onday 2, and then the following prices are recorded.Day 3 - it rallies to 312p and closes at 309pDay 4 - it rallies to 314p and then falls to 300p and closes at 300pDay 5 - it rallies to 312p and closes at 312pA point & figure chart constructed on closing prices would record a clear buy signal asshown in the chart on the next page (figApp 1.5).
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345
330
315
300
fig App 1.5
But no buy signal has in fact occurred. The market has met selling every time it has gotto 312p or above. It is precisely the wrong time to be buying at 312p, right up against theresistance which has so far prevailed. You should be doing nothing, but if a gun was putto your head you’d sell, not buy at 312p. The real-time chart (fig App 1.6) shows that themarket is still in a state of equilibrium.
194
Appendix 1 - Construction of a point & figure chart
345
330
315
300
fig App 1.6
You have only to do a little trading to see how often these resistance levels hold at the topof a consolidation/equilibrium pattern. It’s a potential disaster to use closing prices toconstruct a point & figure chart for swing trading purposes.
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APPENDIX 2Swing charting with Rio TintoRio Tinto is an excellent candidate for swing trading. It is one of the 50 biggest companies listedon the London Stock Exchange, it attracts high volumes of turnover and it sufficiently volatileto have crisp, well-defined swings. I examine the period February 2000 to April 2002.Rules
• Execute swing charting method. Stop buy and sell orders to be placed 6p above or belowrelevant buy or sell point (see page 46).• Move stop loss to entry point after swing has moved 6% in your favour.• Take profits when market has moved 11%.• Double up in potential linear phases. Take profits on half position at 11% and onremaining half at 25% or when there is an extreme RSI reading.• Do not pyramid except when stop loss completely protects first position.
1Sell
BuyBuy
3
Buy
2
Buy
4
5
Sell
6
Buy
8
7
Sell
fig App 2.11.
8.2.00 Sell short at 1154p. Take 11% profits (127p) on 10.2.00.
2.
6.3.00 Sell short at 964p. Stopped out at entry point on 10.3.00.197
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3.
16.3.00 Buy at 1075p. Stopped out at entry point on 17.3.00.
4.
31.3.00 Buy at 1018p. Potential linear phase. Take 11% profits on 1 position on 7.4.00.Stopped out at entry point on other position.
5.
17.4.00 Sell short at 948p. Market does edge lower for 2 days, then has a 3 day rallywhich fails on 27.4.00. Don’t add to losing position. The next day it trades up and thefollowing day it gaps open above what might be a swing high. This could be a change intrend signal (with hindsight it was indeed) or a false start. It’s not sufficiently clear to golong, but it is certainly enough to kill off the short position for a loss of 80p.
6.
1.6.00 Buy at 991p. Potential linear phase. On 8.6.00, just missed realising 11% profitson one position (by 1p). Stopped out at entry point on both positions on 19.6.00.
7.
21.6.00 Having been stopped out at entry point of linear phase position, re-establish it at1006p, a little above the original price. Take 11% profits (111p) on 13.7.00, and 217pprofits on 24.8.00 when RSI reading is 89.1.
8.
27.7.00 Buy at 1061p. Justified in adding a position here because the stop loss on thelinear phase positions is at entry point so there is risk on one position only. Take 11%profits (117p) on 22.8.00.
BuyBuy
15
Buy
16
13
17
Buy
14109
Buy
Sell
Sell
11
BuySell
12
fig App 2.29.
1.9.00 Buy at 1138p. Stopped out at entry point on 13.9.00.
10.
20.9.00 Sell short at 1090p. Ignore RSI signal of 27.9.00. Too soon after position entered.
198
Appendix 2 - Swing charting with Rio Tinto
So is the RSI signal of 29.9.00, but on this occasion it is only 11p away from the 11%target. Take 10% profits (109p). If fact if one had waited one could have achieved thefull 11%.11.
25.10.00 Sell short at 994p. Potential linear phase. False start. Stopped out next day at1031p for a loss of 37p x2=74p.There then follows a massive rally into 31.10. Although no change of trend signal hasbeen given, this upward move has lasted too long and gone too far for Rio still to be in ashort-term downtrend. Await developments. After a high on 7.11, Rio makes an orderlydecline, reinforcing the impression that the trend has changed.
12.
23.11.00 Buy at 922p. Should be a potential linear phase, but because the trend change isnot 100% certain, put on only one position. Take 11% profits (114p) on 5.12.00. Notrading in December after 10.12.00
13.
15.1.01 Buy at 1196p. False start. Stopped out next day for loss of 41p.
14.
17.1.01 Buy at 1205p. False start. Stopped out next day for loss of 57p.
15.
19.1.01 Buy at 1211p. Take 7.4% profits (90p) on 12.2.01 against RSI reading of 89.6.
16.
28.2.01 Buy at 1284p. Failed. Sell at 1225p on 14.3.01 for loss of 59p.
17.
14.3.01 Sell short at 1225p. Stopped out at entry point on 29.3.01.
18.
2.4.01 Sell short at 1197p. Potential linear phase. Stopped out at entry point on 5.4.01.
19.
10.4.01 Buy at 1255p. Take 11% profits (138p) on 18.4.01.
20.
27.4.01 Buy at 1364p. Potential linear phase. Stopped out at entry point on 29.5.01.
21.
31.5.01 Buy at 1406p. Failed. Loss of 57p.Note that at this point, five months of the year 2001 have passed and gross profits of only14p have been made, not enough to cover commission charges, but that is typical of thegrind that swing traders have to put up with. If you lose patience at this point, you missthe next two trades.
22.
12.6.01 Sell short at 1349p. Ignore RSI signal just 2 days after sell signal. Take 11%profits (148p) on 21.6.01.
23.
3.7.01 Sell short at 1268p. Potential linear phase. Take 11% profits (139p) on oneposition on 24.07.01 and 157p profits on close on the same day against RSI reading of 9.5.199
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Buy
21
20Sell
Buy
1817
19
Buy
22
Sell
23
Sell
Sell
25 2624
Buy
27
Sell
Sell
28
30
BuySell
SellSell
29
fig App 2.3
24.
31.7.01 Sell short at 1134p. False start. Stopped out next day for loss of 34p.
25.
2.8.01 Sell short at 1154p. False start. Stopped out same day for loss of 42p.
26.
6.8.01 Sell short at 1172p. Failed. Stopped out on 23.8.01 for loss of 39p.
27.
23.8.01 Buy at 1211p. Failed. Stopped out at 1111p on 10.9.01 for loss of 100p.
28.
10.9.01 Sell short at 1111p. Take 11% profits (122p) on 20.09.01.
29.
2.10.01 Sell short at 1029p. Potential linear phase. Stopped out for loss of 77p x2=154p.
30.
4.10.01 Buy at 1116p. Stopped out at entry point on 18.10.01.
200
Appendix 2 - Swing charting with Rio Tinto
36
Sell
35
34
BuySell
32
33
Buy
Buy
31
Buy
fig App 2.431.
23.10.01 Buy at 1111p. Potential linear phase. Take 11% profits (122p) on 13.11.01 and170p profits on 14.11.01 against RSI reading of 92.3.
32.
30.11.01 Buy at 1302p. Stopped out at entry point on 10.12.01. No trading in Decemberhereafter.
33.
21.1.02 Buy at 1319p. Could be a potential linear phase, but because chart positionmuddied by December trading, put on only 1 position. Take 11% profits (145p) on12.02.02.
34.
25.2.02 Buy at 1426p. Stopped out at entry point on 13.3.02.
35.
15.3.02 Sell short at 1389. Take loss of 40p on 18.3.02 because it looks like a spring trapreversal. Turns out to be a false alarm. Reinstate short position on 21.3.02 at 1384p. Take106p profits on 25.4.02 against RSI reading of 13.6.
36.
4.4.02 Sell short at 1385p. Potential linear phase, but you already have one position, soadd just one. Take profits (prematurely as it turns out) of 107p on 25.4.02 against RSIreading of 13.6.
Overall profit, after commissions, in the region of 62% in 26 months.
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APPENDIX 3Integrating point & figure with swing chartsI wrote an article on the software group Sage in the Evening Standard in early 2002, and as Ipored over the chart it seemed to me to be an ideal candidate for illustrating both swing chartingand point & figure principles, combined with use of the RSI. I accept that the example below istainted by hindsight, but judge for yourself whether you think I have fudged any of theprinciples in this book.There follows an example of how one might have traded Sage throughout 2001, applying theprinciples in this book, including cross checking between the swing charts and point & figurecharts and when in doubt cross checking between the individual chart and the FTSE chart (but,for present purposes, ignoring my conservative approach of initiating a trade only if and whenthe FTSE index swing chart is pointing in the same direction). The integration of point & figurecharts with swing charts when trading individual equities does call for the use of judgment. It isdifficult to write out a fixed set of rules. With that caveat in mind, I will attempt to outline somerules:Outline Rules
• The point & figure chart has primacy. Initiate positions on all triple top and triple bottomsignals and their variations, the bullish and bearish shakeout, and the bearish and bullish signalreversed, unless countermanded by the swing chart. The swing chart does not have to agreewith the point & figure chart - but it must not be diametrically opposed to the point & figurechart.• Raise stop to entry point after Sage has moved 12% in your favour (but only on one positionin linear phases).• Look for linear phases on the swing charts for the opportunity to double up.• Take profits on extreme RSI readings.Sage was in a clear bear trend after heavy selling in December 2000 which caused the shareprice nearly to halve in one month. There were multiple low RSI reading in late December andearly January. It was clear that a substantial (corrective?) rally was coming. It did after 3rdJanuary when Alan Greenspan lowered rates.Note: Some of the numbered items of comment below pertain only to one type of chart so inthose few cases, that number does not appear on the other type of chart. It is not an error.
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2
351
10
49
7
13
8
14
6
234
512
197
118
13
1514
6
figs App 3.1 & App 3.2204
Appendix 3 - Integrating point & figure with swing charts
1.
10.01.01 Triple top buy signal at 310p. Buy.
2.
31.01.01 RSI at 80.8 when Sage closes at 380.75. Difficult to make an objective decisionhere. Hindsight intrudes too much. There would have been an overwhelming temptationto take such a large profit (23% in 3 weeks). But I won’t count it.
3.
8.02.01 Bullish signal reversed sell signal at 340p. Take profits of 30p. But the swingchart looks like it is completing a swing low, so no short position established, whichunfortunately means you miss a good chunk of the downtrend.
4.
20.02.01 Still no clear signal from the swing chart but it is clear that this can’t still be anuptrend when the P&F chart gives descending triple bottom sell signal. Now waiting fora rally on the swing chart to set up a potential linear phase sell signal.
5.
7/8.03.01 Rally on the swing chart, but third day up is not clear. FTSE has very clear 3day rally, and one that suggests a linear phase. When Sage executes a bearish shakeout at310p go short in double quantity.
6.
3.04.01 RSI reading 17.1. Take profits of 89.25p x2 =178.5p at 220.75p. RSI falls below15 intraday the following day.At this point, you’ve made a return of about 65% in just over 3 months, and you think it’seasy. "Mistake. Big mistake. Huge". (Julia Roberts: Pretty Woman).
7.
18.04.01 Spread triple top buy signal at 270p. Buy. Confirmed same day by swing chartbuy signal. 24.04.01 Stopped out at entry point.
8.
26.04.01. Potential linear phase swing chart buy signal at 262p. Confirmed the same dayby FTSE swing chart buy signal in potential linear phase. Re-establish long position at262p in double quantity. Stopped out of one position at entry point on 9.05.01.
9.
22.05.01 Gap opening (not properly shown on this chart) triple top buy signal. But formassive gap would have added to long position.
10.
23.05.01 Negative price action. Having made a higher high than the previous rally by onebox, Sage then subsides. Relevant in view of gap.
11.
1.06.01 Outside day and clear swing low established at 273p. Raise stop on remaininglinear position to 270p.
12.
11.06.01 Fresh rally fails to take out old highs. Standard Dow theory weakness. Ready togo short if swing low breached even though P&F chart will only give a debatabledescending triple bottom sell signal.
13.
12.06.01 Stopped out of long position for profit of 8p and reversed to short position at 270p.
14.
19.06.01 Oversold reading of 16.1 on RSI. Cover shorts at 245p for profit of 25p.
15.
25/26.06.01 3 day swing high completed, plus bearish shakeout on point & figure chart.Sell short at 250p.205
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19
16
26
171815
2125
23
26
16191718
2720
2122
252324
figs App 3.3 & App 3.4206
Appendix 3 - Integrating point & figure with swing charts
16.
2.07.01 Triple top buy signal and breach of swing high. Cover shorts, but do not go longbecause FTSE appears to be completing a 3 day countertrend rally in a potential linearphase. This is a plain example of the swing chart countermanding an otherwise clearsignal on the point & figure chart. It seldom happens, but it’s useful when it does. Losson short position = 20p.
17.
3.07.01 Triple top buy signal was clearly false as FTSE linear phase begins and Sage chartexecutes a spring trap reversal and a bull trap sell signal on the P&F chart. Reinstateshorts at 250p in double quantity.
18.
30.07.01 Triple top buy signal with long tail and breach of swing high at exactly the samepoint. Cover shorts at 235p for profit of 15p x 2 = 30p and go long at 235p.
19.
2.08.01 RSI shows overbought reading but too soon (regrettably) after buy signal to act.Stopped out of long position at entry point on 7.08.01.
20.
14.08.01 Although the swing chart suggests a linear phase buy signal, the point & figurechart has executed a high pole by falling all the way back to 210p and it is not lookingremotely bullish. High poles are fairly common so it is not conclusive, but an additionalnegative feature is that the supposed linear phase buy signal is occurring at 207.5p wellbelow the initial buy signal at 235p (see trading tip page 80). Follow the neutral point &figure chart and stand aside.
21.
7.09.01 Triple bottom sell signal with truncated final column and swing chart sell signalat same point. Sell short at 195p.
22.
10.09.01 Oversold reading on RSI of 15. Ordinarily this would be ignored because itcomes just 1 day after the sell signal. But I’m not going to count the profits immediatelyafter September 11 so I will assume this short position would have been covered on 10.09at 181.25p for a profit of 13.25p.
23.
27.09.01 Bearish shakeout sell signal and swing chart sell signal. Establish short positionat 160p but watch carefully because weekly RSI already approaching oversold (20.4) andmarket has already fallen 40% in less than 2 months.
24.
3.10.01 Striking double bottom on bar chart plus massive outside day. Cover shortposition at entry point.
25.
4.10.01 Sage gives an ascending triple top buy signal, and it breaches its swing high butit declines for the rest of the day. At this point, a real time point & figure chart would haveone extra column of Xs and Os as the ascending triple top stuttered before burstingupwards I accept that a loss of 20p or thereabouts is likely to have been incurred beforea long position was re-established on 10.10 at 185p.
26.
15.11.01 RSI overbought reading of 82.1. Take profits on long position at 272p for aprofit of 87p.207
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27.
4.12.01 Although nominally a linear phase buy signal appears to be in the offing, it issomewhat late in this short-term uptrend for such a signal. The linear phase has alreadytaken place. Sage has doubled in price in just 10 weeks. It is also December, that leastreliable of months. Stand aside.
The above history is typical of the life of a swing trader. Sage had two linear phases. One wasforeseen (in March), which resulted in a doubled up profitable position. One was not (inOctober), but still yielded good profits. Overall, there were:• 7 profits totalling 371.75p• 2 losses totalling 40p• 4 scratch tradesTotal net profit was 331.75p, a return of over 100% after commissions, unleveraged.Interestingly, this result could even be improved upon by disciples of Baruch (take profits early).Take the same 13 initial trades set out above, but• take profits of 12% automatically