ACTICS• My approach• Profit maximisation techniquesStop lossesSetting profit targetsLinear phases• Trading all the swings
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Marc Rivalland on Swing Trading
My approachChoose the right security
My 3bar/1 bar swing charts work well with most stock indices. I tend to stick to the FTSE 100,the Dow, NASDAQ (I chart both the Composite index and the trading vehicle, the NASDAQ100), DAX and S&P 500, in approximately that order. They also work well with the highvolatility, high volume stocks i.e. the TMT sector, the financials (banks and insurers), and basicmaterials. Since that is quite enough to cope with I don’t bother with anything else.Choose the right moment
I trade nearly all the swings which occur in the FTSE 100 and the Dow during the course of theyear. An example of how lucrative this can be is contained at the end of this chapter. Why do Isay ‘nearly’ all the swings? Because there are three occasions when I desist.1.
It is dangerous to initiate a position much after 7th December each year. Just asnewspapers have their silly season in the summer when there are no politicians to lampoon,so the stock market has a silly season in December. Hedge fund traders and fund managerswho have secured their bonuses do not want to risk them. Even those who have fared lesswell do not want to make any big mistakes so late in the year. Make a mistake in Januaryand you have 11 months to redeem yourself. Make a mistake in December and the sands oftime have run out. Exaggerated price movements are often seen in December which arequickly reversed. Chart signals in the second half of December are particularly unreliable.
2.
I will not initiate a new short position if the 5 week RSI is oversold. I will not initiatea new long position if the 5 week RSI is overbought. You can read this chapter withoutknowing the detail underlying this rule, which is to be found at the end of Chapter 10.
3.
As mentioned in the last chapter there are occasions when the charts appear equivocal,at least in real-time. This is particularly so when the market rallies through a swing high(or falls through a swing low) which was established just 2 or 3 days earlier. Some mightsay this difficulty is my own creation since I have bent Gann’s rules to allow for complexswing highs and lows to be formed instead of sticking to a rigid mechanical formula. Iplead guilty, but without remorse. I believe complex swing highs and lows are a reality.The added flexibility which allows me to identify them and trade them as swing highs andlows is, I believe, a huge advantage. The price attached to that advantage is the occasionalambivalent picture. Intermarket cross checking, which I deal with immediately below,helps me make a decision. But if both intermarket cross checking and an examination ofmy point & figure charts does not help me reach a firm conclusion about whether themarket is making a complex swing high or changing trend, I will liquidate my existingshort position (just in case it is a change of trend), but I will not establish a new longposition. So there is a tiny number of change of trend signals which I do not trade. I feelquite comfortable about this. When in doubt, stay out is a well-known market aphorism.
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Swing Charting Tactics
Intermarket Cross Checking
One of the most important tools in analysing an equivocal presentation on the chart is to look atallied markets or allied shares. A particularly good example of an intermarket clue occurred inFebruary 2002. On 12th February the FTSE chart gave a sell signal after a 4 day rally, but thenturned around as strength in the Dow led the market higher. On 14th February the FTSEpowered through the putative swing high. Was this a change in trend? According to the rule ofthumb that the market should stay below its swing high for at least 3 days before a breach of aswing high denotes a change in trend, this did look like a false start (which is what it turned outto be). But the FTSE had closed above its 20 day moving average, and the minor 25pt point &figure chart had generated a buy signal. So in real time, there was room for some doubt if onelooked purely at the FTSE chart.
New Swing High orChange of Trend ?PutativeSwing High
Sell
fig 5.165
Marc Rivalland on Swing Trading
But all one had to do was look at the S&P and NASDAQ charts. Not only were they in cleardowntrends but they were miles away from the previous swing highs (unlike the FTSE). It wasvery likely that they were completing a 4 day rally. There was no indication to buy the S&P andthe NASDAQ (fig 5.2), and indeed every indication that a fresh sell signal was about to begenerated. At its highest, the NASDAQ and S&P might eventually turn around, but it would takesome time. Answer: Doubts about the FTSE swing high are dispelled. Sure enough theNASDAQ and S&P did break to new lows, dragging the FTSE down.
Swing High
fig 5.2Likewise, if you are trading in banking shares and a particular bank looks like it is setting itselfup for a swing chart buy signal, ask yourself what the other banks are doing. There is no needto try to tease a particular meaning out of a chart. There are often plenty of clues from the chartsof related shares or markets.
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Swing Charting Tactics
Profit maximisation techniquesThere are three additional devices which I use to maximise profits from trading index futuresand options on swing charting principles:• Moving my stop losses up to my entry point• Setting profit targets• Doubling up during linear phases
A. Stop losses
Initial stop losses(i) Continuation of trend signalsWith a continuation of trend signal, the place to put one’s stop loss is obvious - justabove the putative swing high if selling short or just below the putative swing lowif going long.I place the stop loss as soon as my new position is initiated. If it turns out the nextday or the day after that it is a false start (market moves against you the very nextday, continuing to form its swing high/low) I will be stopped out. I will wait for thenew swing/high low to finish its formation before re-entering my short (or long)position.(ii) Change of trend signalsWith a change of trend signal, there is often no good place to put a stop loss. Quiteoften the market makes a peak and then changes trend by crashing through aprevious swing low, without having first made a lower high. The stop loss on thenewly entered short position should be placed above the old highs, but frequentlythat old high is miles away. It can make the risk/reward ratio hopelessly lopsided.A good example is the FTSE in January 1994 (fig 5.3). After making a new all-timehigh, it plummetted straight through the swing low of 28th January at 3402, givinga clear change of trend signal (and one that was to lead to a 15% fall in the market).The stop loss should have been placed above the old highs at 3540, but manytraders would feel uncomfortable with a stop loss of just over 4%.
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Marc Rivalland on Swing Trading
Sell
Swing Low
fig5.3There are 3 solutions:1. Liquidate your existing position but don’t initiate a new position based on thechange of trend signal. This is my least favourite option.2. Place an arbitrary stop loss, consonant with the risk you’re prepared to take e.g.a stop loss say 2.5% away even though there is no relevant chart point at that level.3. Trade the change of trend signal by using an option or option spread e.g. insteadof selling futures as I would do on a continuation of trend signal, I buy a put optionor a bear spread. That fixes your potential loss. It also has the very great advantagethat on those few occasions that there is a (false) hint of a spring trap reversal, oneis not panicked out of the position.68
Swing Charting Tactics
Traders should choose whichever option best suits their risk profile. Nowadays I use acombination of 2 and 3 above.
Moving stop lossesAs the Maginot line proved, fixed defences have their limitations. My stop losses do not remainfixed.When a false or failed signal happens, I am quite sanguine about it. You’ve got to get used totaking losses. They are inevitable.When I deduce that the market is headed in a particular direction, and I put on an appropriateposition and it does head in that direction, I am content. The swing chart has ‘worked’. But sincethe chart describes only an imbalance of supply and demand, and future events may rectify thatimbalance, even turn it the other way, I find that chart signals have limited durability, unless themarket is in a linear phase.It sets my teeth on edge when substantial profits evaporate and I ultimately lose money on whathas been a (briefly) successful chart signal.The great traders of yore said: never let a profit run into a loss.Whilst it is impossible to follow that stricture literally, I do follow it in spirit.(i) Continuation of trend signalsIn all non-linear phases, as a general rule, I move my stop loss up to my entry pointwhen the FTSE has moved 100 points in my favour. This does result in my beingstopped out needlessly on a handful of occasions but mostly it saves me a lot ofmoney. I do the same for the Dow when it has moved more than 180 points in myfavour.When I perceive (rightly or wrongly) a linear phase, I will move my stop loss onmy regular position as soon as the market moves 100 points in my favour, but I willnot move my stop loss on my linear phase position. This is explained below.
(ii) Change of trend signalsWith swing charts (and point & figure charts) there is often a little stutter before achange in trend really gets going, so with change of trend signals, I give the marketa little time (3 clear days after the day of the signal) to prove itself before movingmy stop loss to the entry level after the FTSE has moved 100 points in my favour(180 points for the Dow).
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Marc Rivalland on Swing Trading
Moving stop losses with individual equitiesLikewise when I trade individual equities, I am quick to move up my stop. Of course this is amental stop since the electronic order book will not accept stop orders. Alternatively, if I’m inCourt, I leave the stop order with my broker/spreadbetting firm on a "not held basis". I calculatewhen to move my stop loss to the entry point on the individual equities by a bit of back testing,but it tends to be after the market has moved about 6-7% in my favour.I regard moving my stop loss as a vital tactic for successful swing trading. Whether or not youaccept the detail of the above "rules" about moving your stop loss, I do suggest you embrace theprinciple.
B. Setting profit targets
At this point I commit something of a heresy. I take profits early. One is always told to run one’sprofits and cut one’s losses. Certainly losses must be cut, but swing charting is such a short termdevice that I’ve found that taking profits early makes little difference to one’s bottom line. Whenthe markets are in a linear phase one can indeed run one’s profits. But linear phases are rare. Youwill get one, maybe two a year. There are long passages of time in each year when the marketis either in a choppy sideways phase or it is trending very gently up or down with occasionalsharp breaks.Back testingBefore I go on to the subject of profit targets, and what may or may not be achievable with swingcharts, I should deal briefly with back testing. Any trader should be able to write down on asingle piece of A4 paper the broad parameters which will lead him to enter and exit positions.‘Buy when I think its going up’ does not qualify. If you can’t write down what makes you buyand sell, you had better be lucky or an intuitive genius. Once you have a broad method, backtest it on the charts. If you are using moving averages or any of the popular arithmeticalindicators, you can back test by using the optimiser facility which most modern software possesses.Back testing won’t prove that you will definitely make money, but it may prove that you won’t.What is more it will reveal which securities are not susceptible to the type of analysis or chartmethod you intend to use. Swing charting will definitely not work on every stock (see below).I have back tested the swing charts on the FTSE index from 1985 onwards and the resultsreveal an annual return of as low as 6% and as high as 42%.This may seem disappointing to some, but it is not to me. Most of the results fall in the 12-24%range. With the benefit of leverage which futures, options and CFDs provide, an unleveragedyield of 6-42% is perfectly acceptable in my view. In any event, I try to boost the return byincreasing my position in linear phases (see opposite).70
Swing Charting Tactics
Wealth warning: Back testing does not indicate what is likely to be achieved. It indicates themaximum which is achievable. There is a massive psychological component to trading themarkets. If you don’t know what I mean, you’ll find out in due course. Inexperienced traderswill consistently do worse than backtested results and even experienced traders will onlyoccasionally match such results. Back testing merely gives a rudimentary idea of what ispossible.The right targetI doubt that there is a single fixed profit target that is right for every phase of the market, yearin year out. Selecting a profit target is something you need to tinker with continuously. Theprofitable FTSE signals in the years 1999 to 2001 were as follows:
Gain
100-149
150-199
200-249
250-299
300-399
400+
1999
5
2
2
2
5
0
2000
4
3
3
3
4
1
2001
1
3
6
0
2
2
Each buy and sell signal has been counted from the point it was triggered to the lowest/highestpoint of that move before there was another swing high/low or change in trend.As a matter of experience, I find that the best targets for me are 150 points and 300 points onthe FTSE. In non-linear situations, I take half profits invariably when the market has moved 150points in my favour. I take full profits somewhere between 150-300 points. I tend to play it byear as to when exactly I get out. Taking modest half profits never bothers me. I like puttingmoney in the bank.ReliabilityFor the sake of completeness, I should also deal with the failures: failed signals, false signalsand false starts. In the last 3 years, the following losing trades were recorded in the FTSE.Change of trend signals
Continuation of trend signals
1999
3 out of 8
6 out of 16
2000
1 out of 10
7 out of 16
2001
3 out of 7
3 out of 1371
Marc Rivalland on Swing Trading
That looks very good doesn’t it? An accuracy rate of two out of three. It is half true. If you’relooking at it from the point of view of how many trades made losses, it was indeed one in three.But some of the successful trades did not make me any money, because I raised my stop loss tothe entry point after the market had moved more than 100 points in my favour, and my stop losswas later hit. Sometimes I was right to do so, sometimes not. I haven’t re-calculated theaccuracy rate to take account of those occasions because it seems to me that those occasionsshould be counted as a success. The swing chart signals worked. My profit objectives suited myrisk profile, but someone who had smaller expectations (say 100 points per trade) would haveprofited on all of those occasions.C. Linear phases
I use the term ‘linear phase’ as a shorthand way of describing that phase of the market when asubstantial move unfolds. The signature of a linear phase is a substantial change in price overseveral weeks or months, during part of which time the price movement resembles a straightline. Obviously the swing trader is keen to capture as much as possible of such a move.Linear phases are very often connected to a theme, like ‘Enronitis’. I can’t think of a reliableway of identifying all linear phases in advance. If anyone could identify linear phases inadvance, they would sit out all the difficult phases of the market, and roll in money every timea linear phase presented itself. But I have found one mechanical way of catching many linearphases. The following is a method I use to increase the size of my position upon the assumptionthat a linear movement may be in the offing.The first continuation of trend signal after a change in trend often yields the best profits.If there is going to be a long run, that first countertrend move is the one to watch for.It is clear from analysis of swing charts that some change of trend of signals can be treacherous,hence the discussion about intraday reversal and spring trap reversals. They can also be veryprofitable. But if a change of trend signal is going to be short-lived, it will seldom go on to giveany continuation of trend signals. If there is a false change in trend signal or an embryonicchange in trend about which the market has second thoughts, this usually shows up early in thecharts - usually within days. But when you do see a continuation of trend signal which followsa change in trend signal, it is an important milestone in the development of the trend.W.D. Gann was of the same view. It was at this stage of the trend that he was keen onpyramiding, as he called it. Effectively, I assume that any market which has given both a changeof trend signal and a continuation of trend signal is about to set off on a long profitable run. Ithen double up my position (or at any rate increase it substantially). Naturally this assumptionis not always borne out, but it is seldom costly. I set out here a subset of rules to capitalise onpotential linear phases.
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Swing Charting Tactics
Linear phase rules
Rule 1Look for the first countertrend swing of at least 3 days after a change in trend signal, inline with swing charting principles.Some sort of filter is needed to exclude those continuation of trend signals where the marketdoesn’t really have the momentum to set off on a long run. I am sure a variety of indicators canbe used. I use a 14 day moving average, which is short enough to give some idea of short-termmomentum although not too short to turn on an extended countertrend rally.Rule 2After the 3 day countertrend move has been identified, check by referring to the close thatthe 14 day moving average is still moving in the direction of the supposed trend.Note that since the trade will be put on the following day, this indicator effectively lags by oneday. You’ll see what I mean below. Note also that it is purely the slope of the moving averagewhich is important. For these purposes, it is irrelevant whether the market price is above orbelow the moving average.What stop loss rule should be employed? Clearly in a linear phase one wants to hang in for along run. At the same time with a doubled up position, one is vulnerable to making a doublehelping of losses. So I adopt a hybrid position. I set a profit target of 200 points on one position,my normal position size, and I move my stop loss to the entry point as soon as the market hasmoved more than 100 points in my favour. In other words I treat it much the same as a normalswing. Then I take an increased position (up to double in total) on the linear phase. On thisposition, I do not move my stop loss. I am willing to take the extra risk for the extra benefitbecause linear phases can be so lucrative.Rule 3Do not move your stop loss to entry point on linear phase element of your position.Rule 4Do not take any new positions between 7 December and 31 December.
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Marc Rivalland on Swing Trading
2Sell
1Sell
73
4
6
98
5
Sell
fig 5.4Apply that to the years 2000 and 2001 on the FTSE
Max Profit/Actual loss
1.
5.1.00 Change of trend to down.
2.
18.1.00 First countertrend rally. 14 day moving average (M14) is stillmoving lower as of 17.1.00. Market rallies shortly after opening to makenew highs. Place sell stop at 6637 under lows of 17.1.00. Stop triggered lateron 18.1.00.
3.
1.3.00 Change of trend to up as complex swing high of 24.2.00 is taken outon the fourth day after the swing high was made. No countertrend dips onthis upswing. So even though, with hindsight, this did turn out to be a briefbut steep linear phase, it would not have been identified as such. Nomechanical method is perfect.
4.
6.4.00 M14 not satisfied. The moving average was falling on 5th (and 6th)April. Filter works successfully as this signal ultimately fails.
5.
13.4.00 Change of trend to down.
74
+664pts
Swing Charting Tactics
6.
27.4.00 Apparent first countertrend rally but it’s a false start.
7.
3.5.00 Now the swing high is formed. M14 is satisfied. Sell short at 6311below the low of 2.5.00.
8.
30.5.00 Change of trend to up as swing high of 16.5.00 is taken out.
9.
13.6.00 First countertrend dip. Everything sets up perfectly for a new linearphase but the market does not oblige. After limping upwards for 7 days, itflops through the stop loss. A failed signal.
1112
Sell
13
10
-96pts+319pts
-51pts
Sell
1415
16
17
fig 5.510.
22.6.00 Change of trend to down.
11.
11.7.00 First countertrend rally. M14 satisfied, but it’s a false start.
12.
13.7.00 By the time the real swing high has been established, M14 notsatisfied; it is rising so this swing would have traded as an ordinary swing,not a linear phase, which is just as well because a normal, rather than asupernormal, profit was all that was available.
-54pts
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Marc Rivalland on Swing Trading
13.
16.8.00 (Confirmed by a very clear signal from the point & figure chart.)Change of trend to up, but after a sharp 2 week rally there is an equally sharpplunge and no countertrend dip clearly presents itself.
14.
14.9.00 is an equivocal signal, but any thought of a linear phase would havebeen countermanded by M14 which was falling. The trend changes back todown on 18.9.00.
15.
9.10.00 First countertrend rally. M14 satisfied. Sell short at 6341.
16.
24.10.00 Change of trend from down to up.
17.
14.11.00 First countertrend dip, but M14 not satisfied. No linear phasedevelops so the filter works correctly again.
+324pts
Analysis: The main linear phase of 2000 (January/February) was captured well. The secondlinear phase (March) was not, but it was brief. Trading the change of trend of signal meant thata profit would indeed have been made, but not on a doubled up position. Two other reasonableswings were captured. There was one modest failed signal costing 51 points. There were 2 falsestarts which would have been avoided by a 2 bar trigger for the buy/sell signal. But waiting forthat second bar would have cost, over the year as a whole, much more than actual 150 pointsloss on the false starts.So far I have just set out the maximum profit available. How do you actually realise theseprofits? Frankly I tend to play it by ear when I’m in an assumed linear phase. I take half profitsvirtually automatically at about the 200 point level and run the remaining position with an eyeon the RSI (see Chapter 10). You could, however, use a mechanical method for realizing profits.An example is:Rule 5After the market has moved 200 points in your favour, take profits on the third day theFTSE crosses the Bollinger Band.On the next page, I have applied a 21 day weighted Bollinger Band set at 2 standard deviationsto the FTSE chart so that you can see the application of this rule.For the year 2000, the results are good:• You get out the day of the low of the entire January/February linear movement and close tothe lows in the other 2 swings.• You capture 627 points on the 18.1.00 sell signal, 271 points on the 3.5.00 sell signal and
76
Swing Charting Tactics
246 points on the 17.10.00 signal.• Net profit for the year on linear phases = 943pts equivalent to about 15% on the linear phaseelement alone.
Take profits
Take profits
Take profits
fig 5.6In the powerful downward linear phase of June/July 2002, the Bollinger Band rule would nothave worked nearly so well. A gain of 474 points would have been achieved, which is not badat all. But it was less than half of the 1000 points on offer during that linear phase. You will findthat the same applies if you back test rigorously my Bollinger Band rule over a decade or more.Some years it works brilliantly, other years it gets you out too early and in yet other years it failsto get you out at all because the linear phase ends after only 2 crosses of the Bollinger Band.I’ve mentioned this “rule” to feed the powerful desire of investors and traders for a metric. Thetruth is I doubt that there is a single mechanical way, applicable to all kinds of markets, whichwill close out a successful position at just the right time.
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Marc Rivalland on Swing Trading
Now the year 2001.
1
2 3
54Sell
6
7
8
Buy
9
fig 5.71.
24.1.01 Change of trend from down to up as swing high of 2.1.01 andpossible swing high of 19.1.01 is breached.
2.
12.2.01 First countertrend dip. M14 not satisfied. Filter works well, as nolinear phase (or profit of any kind) materialises.
3.
14.2.01 Possible change in trend.
4.
20.2.01 Definite change in trend.
5.
9.3.01 First countertrend rally. M14 satisfied. Sell short at 5981(underneathlows of 8.3.01)
6.
10.4.01 Change of trend from down to up.
7.
25.4.01 First countertrend dip. M14 satisfied. Buy at 5841. Later stoppedout.
8.
3.5.01 False change of trend signal.
9.
13.5.01 LSE closing auction fiasco. Ignore. Trend still up.
78
+701pts
-65pts
Swing Charting Tactics
1110
Sell
Buy
12
13
fig 5.810.
14.6.01 Change of trend from up to down.
11.
3.7.01 First countertrend rally. M14 satisfied. Sell short at 5629.
12.
4.10.01 Change of trend from down to up.
13.
23.10.01 First countertrend dip M14 satisfied. Buy at 5079. Later stoppedout.
+733pts
-76pts
Analysis: Both linear phases are captured well. The second linear phase was in fact worth amaximum of not 733 points but 1409 points. However I decline to count profits after 11thSeptember.Now applying the Bollinger Band rule, it works well with the second linear phase, getting oneout of the market on the very day of the low (10th September), capturing 595 points. It doesn’twork so well on the March linear phase but still manages to capture 404 points. Net profit forthe year on linear phases = 766 points, equivalent to a return of about 13% on the linear phaseelement alone.
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Marc Rivalland on Swing Trading
Take profits
Take profits
fig 5.9Trading tip: I have put forward a 14 day moving average as a filter to exclude some of the firstcontinuation of trend signals which do not appear to have the oomph to turn into linear phases.Another, more imprecise, filter which I use is the level at which the first continuation of trendsignal occurs. If the first continuation of trend buy signal occurs above the point at which thechange of trend buy signal occurs, that is obviously a good sign. The market has held onto itsgains, and it is giving a repeat buy signal at a higher level, which is clearly indicative of theenthusiasm of the buyers. If the first continuation of trend buy signal occurs at the same levelas the change of trend signal or even slightly below it, it is plainly less emphatic than one wouldlike, but still acceptable in my opinion. But where the first continuation of trend buy signaloccurs more than 3% below the original buy signal, I am deeply sceptical that any linear phasewill unfold. It is hardly a rampant bull market that gives up all of the gains it has made on thechange of trend signal, and then loses 3% more before giving a repeat buy signal.
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Swing Charting Tactics
Trading all the swingsThus far I have concentrated on 3 techniques which I use in an attempt to maximise profits,namely trading linear phases, moving my stop loss to the entry point at an early stage andbooking half profits early. As you’ve already seen, catching the linear phases can make atremendous difference to a trader’s bottom line. However it is not only the linear phases whichone should trade. Trading all the swings is profitable although there can be long phases in whichit is a bit of a grind (the FTSE in January to April 2002 being an irritatingly good example). Inthis section I set out a typical example of how one might trade all the swings.NASDAQ 100The NASDAQ has caused much sorrow to traders, but see below how uncomplicated it was totrade all the swings. On this occasion I have used the NASDAQ 100 over the 12 months priorto writing this chapter (late April 2001 to end April 2002). In order not to complicate matters, Ihave run the example without doubling up on the linear phases. I have assumed a 2 contractposition for the purposes of taking half profits.
Rulesa. In non-linear phases take half profits on a gain of 100 points and half profitson remaining position on a gain of 140 points.b. In linear phases, take half profits on a gain of 140 points, and run remainingposition until the 5 day RSI falls below 14 or rises above 86 (the RSI is amomentum indicator which I use as a tool for taking profits. It is explained inChapter 10. For the moment, you’ll just have to take it on trust), or until thetrend changes, whichever occurs soonest.c. Raise/lower stop to entry level after 4 days, provided market has moved 100points or more in your favour.d. Do not initiate any new positions whilst weekly RSI is below 18 or