regards indices. I tendto place my stop either 1 or 2 ticks above/below the swing high/low when trading equityindices. You may think that a single tick may not be that important, but it has the value ofcertainty.Sometimes one gets caught by a false signal but I’ve never found it possible to place my stopbuy or stop-sell order at just the right level to avoid a false signal. Some false signals trade 2 or3 ticks through the key level, some trade 5 to 10 ticks through, and some 20 or more. When Itraded Treasury Bonds I used a stop 3 ticks away, because that did seem to avoid a number ofoccasions when the market traded through a previous high by 1 or 2 ticks without the breachhaving any enduring significance.As regards individual equities, it is much trickier. The electronic order book does not accept stoporders; there are rogue orders at the beginning of the day, and it frequently happens that a largesell or buy order is badly handled by a broker/dealer (by hitting every bid or taking every offerin sight without regard to the real, unstated depth of the market) which distorts the markettemporarily.46
Modified Swing Charts
As a result, I do leave some margin for slippage when trading individual equities. It is often asmuch as 0.5%, and I suspect with illiquid stocks (which I do not trade), an even larger cushionmight well be appropriate. So for example with the short sale of HSBC, I would have enteredthe position only when the swing low was breached by 5p i.e at 1028p. A sensible idea is to backtest a security which you want to trade. Does it give many false signals and, if so, is there acertain point at which one might place a stop loss in order to avoid a reasonable percentage ofthe false signals?• Stop losses. The lower high made by HSBC (point E) also provided a convenient placeto put a stop loss against the short position established at 1028p. The bearish conclusionthat one had drawn when HSBC made a lower high at 1075p and then crashed through1033p would be invalidated if thereafter the share price reversed and rose above thatselfsame lower swing high. The stop loss should be placed at 1080p. That represents astop loss of 5%, which I consider to be high - near the outer limit of what is acceptable.My normal stop loss on the FTSE and the Dow is 2 - 2.5% at most; on individual equitiesit is around 3.5 - 4%.• Note that in HSBC’s case 12 trading days elapsed between the swing low of 5thFebruary (point D) and the collapse through those swing lows. That made it relativelyclear that the 5th February was a swing low, and that the days following it constituted anattempt to resume the main trend, an uptrend. They were not a continuing attempt to forma swing low. We will see in due course situations which are not so clear.• These change of trend signals occur relatively frequently (about 4 to 9 times a year). Butthe swing chartist does not actually believe that each and every time a swing low or highis breached, there is a major new bull or bear market underway.The swing chartist knows that a percentage of the ‘change of trend’ signals will be false, apercentage will result in an embryonic new trend about which the market has secondthoughts, before reversing, leaving the swing trader with a small profit or none at all, anda percentage will result in a substantial money-making opportunity.For example, in 1999 the FTSE gave 8 change of trend signals, of which 3 were false and 2 lednowhere (gain of only 100-150pts) before reversing. In 2000, there were 10 change of trendsignals of which 1 was false and 1 led nowhere. In 2001, there were 7 change of trend signalsof which 2 were false. If these numbers make unhappy reading, worry not. It all works out inthe end.
47
Marc Rivalland on Swing Trading
Continuation of trend signalsLook at all the charts (except of course the HSBC chart) in this chapter hitherto. They all portraycontinuation of trend signals.Once a change of trend has been signalled when the market breaches a previous swinghigh or low, the swing trader should be watching and waiting for a countertrend swingwhich lasts a minimum of 3 days.I attempt to use market corrections to buy low and sell high. Naturally, I want to sell as high andbuy as low as it is possible to do without taking an undue risk. Once there is a 3+ day rally in adowntrend (or a 3+ day dip in an uptrend), I am eager to identify as early as possible the endingof the correction. I assume that the first sign that the rally (dip) has failed means that the marketis ready to resume the main trend.What is the first sign of failure of a rally? I regard it as a sign of failure when the marketbreaches the low of the previous day.So as soon as there has been a 3 day rally in a downtrend, I place a stop sell order below the lowof the previous day. The sell order may be placed during the third day (see page 36 on outsidedays), or before the market opens on the fourth day (if there have been 3 consecutive days up)or before the market opens on the fifth, sixth, seventh or eighth day (because the market mayhave made a complex swing high, during the course of which a number of inside days and downdays may have intervened). If this is unclear please re-read the section on complex swing highsand lows. Each day that the rally fails to break down, I move my stop sell order up to just belowthe low of the previous day.The ideology underlying the continuation of trend signal is clear. During a downtrend, sellersare dominating buyers by definition. So it is significant when buyers muster enough buyingpower to reverse that domination. It is even more significant when that reversal provestemporary. Vice versa for uptrends.
Problem areasThere are two main problem areas: false starts and false signals. False starts occur only withcontinuation of trend signals. False signals occur mainly with change of trend signals.False starts
In each of the above examples, the swing trader assumes that the first up day (or down day) aftera simple or complex 3+ day countertrend move means that the swing low (or swing high) hasbeen established. In each of the above examples that assumption was borne out, and the maintrend did resume. But occasionally, that first up day (or down day) turns out to be a false startand the market continues to rally (fall) the very next day. It is plain that the assumption that theswing low or high was already in place has proved incorrect. That doesn’t mean that the main48
Modified Swing Charts
trend will not resume. It usually means that its resumption has been postponed. Look at the chartfor BSkyB in February 2000.
1
82Buy
43
5
67Buy
PutativeSwing Low
RealSwing Low
fig 4.101.
A high is made on 9th February after a steep run at the height of the dot.com mania andit is plain that this stock needs a breather.
2.
10th February is an inside day. Ignore.
3.
11th February is a down day.
4.
14th February is an inside day. Ignore.
5.
15th February is a down day.
6.
16th February is an inside day. Ignore.
7.
17th February is a down day.
8.
18th February appears to be a buy signal after a putative swing low the previous day. Thebreather has ended.49
Marc Rivalland on Swing Trading
But it’s a false start. There are 2 more down days after which the swing low is in place and themain uptrend resumes.• The sole question is whether to hang on upon the continued assumption that the swinglow will be made shortly, or to take a loss and wait for the swing low to prove itself. Ifollow the latter course on 99% of occasions. The result is that a few times a year, I takewhat appears to be a needless loss. But I prefer the swing low to prove itself rather to hangon merely in the hope that the market will stabilise.• These false starts are the biggest disadvantage of my 3bar/1bar style of trading. Astandard 2 day or 3 day swing chart would not have generated a buy signal on 18thFebruary and therefore no loss would have to be taken. But I have considered thisdisadvantage and I find that in the securities which I trade, the advantage of getting inearly, and having a reasonable stop loss, outweighs the irritating disadvantage of thesefalse starts.In 1999, the FTSE produced 4 false start signals out of a total of 17 continuation of trend signals,in 2000 it was 2 false starts out of 16 and in 2001, 1 false start out of 13.• I have read of an alternative way of deciding that the correction is over and the maintrend is about to resume. Instead of placing a stop buy or sell order just above the high orlow of the previous day, one could place one’s buy or sell order at a point whichrepresents a pre-defined % from the swing low or high. Such a method would have muchin common with Kagi charting (although those charts work off the closing price only). Inother words, one goes long or sells short if and only if the market moves more than, say3% from the swing low. That would not have prevented the false start in the above caseof BSkyB and I don’t know how efficient it would be. I’ve never tested it. I’m perfectlyhappy with my method.• False starts are much more common in individual equities especially when notmuch is happening. Individual equities often take longer than market indices toform swing lows/highs.As a matter of impression, false starts in individual equities appear to reduce as the gradient ofan ascent or descent steepens. There is a trading strategy to minimize the effect of false starts inindividual equities: Trade an individual equity with call or put options. In the above example ofBSkyB, on 18th February, buy a call option outright or a bull spread. That way your potentialloss is fixed. When BSkyB continues making its swing low on 21st and 22nd February there isno need to stop yourself out. You hold on in the belief that the swing low will soon be formedand so it proves. If your belief is not borne out, your loss is fixed anyway.False starts and equivocal change of trend signals
Since this topic is the trickiest part of my modified swing charts some recapitulation iswarranted.50
Modified Swing Charts
I have dealt with the typical patterns described by a market when it is making a countertrendswing low i.e a correction in an uptrend. They are:
fig (i)
fig (ii)
fig (iii)
Simple
Simple + 1
Complex
fig 4.11Over three quarters of swing lows are formed by a simple or simple +1 swing low. In a simple+1 swing low, on one of the days before the third down day, the market moves upwards in thedirection of the main trend. In a complex swing low there may be 2 or more such days, but theyare not difficult to deal with because they all occur before the third day down. Until a third redbar appears there is no possibility of confusion.The typical false start occurs the very day after the market appears to have given a buy signal.I superimpose a false start on the above diagrams.
B
B
fig (iv)
fig (v)
B
fig (vi)
fig 4.1251
Marc Rivalland on Swing Trading
In each case the buy signal was a false start as the market continued its downward correctionthe next day. In fig iv it looks as if the market may now make an extended simple +1 swing low.In figs. v and vi it looks as if the market is making increasingly complex swing lows.The right thing to do would be to liquidate your long position as the market breaches theputative swing low, and wait until it forms a new swing low. Frustratingly that often happens thevery next day i.e. in figs iv, v and vi above, the next bars are all blue as the market rocketsupwards, which means that the loss you took on the false start was unnecessary. Butoccasionally the swing low doesn’t happen for several days, or worse, it doesn’t happen at all the market continues falling until it gives a change of trend signal much lower down. I’d rathertake the needless loss than suffer the agony of hoping that a falling market will soon form aswing low. In swing trading, hoping is a sign of error.I added one blue bar (the putative buy signal which was in fact a false start) and one red bar (thenew and real swing low) to figs i,ii and iii in order to create figs iv,v and vi. Even if I had addedtwo blue bars, it seems to me that a subsequent breach of the swing low probably means that themarket is continuing its correction, continuing to form a swing low, rather than changing trend.That would be a two day false start. But if I add 10 bars after the buy signal, during which timethe putative swing low (the red bar before the false start buy signal) is not breached, it isreasonable to assume;a. that a valid swing low was made by that red bar.b. the price action since then (the 10 blue bars) is a struggling attempt to resumethe main trend rather than an attempt to make a complex swing low.c. when the market crashes through the swing low on the 11th day after the buysignal (the 12th day after the swing low), it is not trying to make a complex swinglow. It is changing its trend.Why I have chosen an extra 10 bars? Because that it is exactly what happened in the case ofHSBC on page 45.So there are no problems differentiating a 1 or 2 day false start from a change of trend. Likewiseit is not sensible to suppose that a market is producing a 10 day false start. The 11 days that themarket spends above the swing low validates the swing low as an important point of support, abreach of which will be significant.But where does one draw the line? 3 days? 4 days? 5 days? As I point out below, I assume thatif a market has spent at least 3 days above its swing low, and then crashes through it, it is not a3 day false start, it is a change of trend. Sometimes, the decision is really very easy. Look at theDow in April 1997.
52
Modified Swing Charts
Swing High3
1Sell
Buy
2
fig 4.131.
The swing high occurs on 8th April.
2.
The sell signal occurs the next day, 9th April.
3.
Just 4 days after the continuation of trend sell signal, the market sweeps upwardsbreaching the high of 8th April.
The fact that the market fell to new lows validates the high of 8th April as a relevant swing high.When, on 15th April, the market breaches that swing high it cannot be a false start, a delayedcomplex swing high. It must be a change in trend.
53
Marc Rivalland on Swing Trading
But what about the Dow in October 2001?
Buy
1
23 4
Sell
Change ofTrend
fig 4.14
1.
On 4th October the Dow makes a swing high, and the next day (5th October) it generatesa continuation of trend sell signal when the low of 3rd October is breached.
2.
8th October is an up day.
3.
9th October is a down day.
4.
On 10th October the market soars through the highs of 4th October. Put your hand overall the bars to the right of 10th October. Would you call this a complex swing high in themaking or a change of trend? The sell signal on 5th October could be a false start,couldn’t it? On the web site I wrote for at the time, I called this a change in trend. I wasinfluenced by the following facts:a. There is a clear although variable relationship between time and price. The swinghigh from the 21st September lows to 4th October had already taken 9 days to form.It is rare for a countertrend rally, a correction, in an index to last that long. If the rallyof 10th October was all part of the same countertrend swing high, it would suggest
54
Modified Swing Charts
that the swing high had taken 13 days to form which is even more rare. The lengthof the time and the extent of the rally were more suggestive of a change in shortterm trend than a continuing correction.b. Although it is difficult to see on the chart, the lows of 10th October were slightlybelow those of 9th October which means 10th October was a bullish outside daywhen it exceeded the highs of 8th October.c. The minor Dow point & figure chart (25pt box) gave a buy signal on 9th Octoberand the NASDAQ Comp main point & figure chart (20pt box) had already given oneof my favourite buy signals on 3rd October.• My general rule of thumb is that if the market spends at least 3 days below the swing highbefore breaching it, it is a change of trend buy signal whereas if it spends 1 or 2 days belowthe swing high it is more likely to be a false start/the making of a complex swing high (andvice versa for swing lows). This rule of thumb works well on equity indices.It is only a rule of thumb. It is precisely because these equivocal presentations may occur thatmost technical analysts, including me, do not look only at one type of chart. When somethingequivocal does turn up, I look at my point & figure charts and the charts of other equity markets.•. As regards individual equities, I am more strict. Individual equities often take quite some timeto make a complex swing high or low, and I am reluctant to assume too readily that a change oftrend has occurred. If I am in doubt, I switch to another equity.
Failed and false signals
I distinguish between failed and false signals. From time to time one gets failed signals. Thechartist’s assumption that there was a new consensus which would take time to develop hasfailed.Failed signals are a statistical certainty. They occur both with change of trend signals andcontinuation of trend signals.With a change of trend failed signal, typical price action is that the market does breach a swinghigh or low and moves in the desired direction, but only hesitantly and after two or three daysof languishing at a level where one’s profits are miniscule, it reverses and forces one to operatea stop loss.In a continuation of trend signal, the failed signal usually takes longer than 2 or 3 days toresolve. Once again the market moves in the desired direction but without any convincingfollow through. The chart of HSBC on page 45 shows a continuation of trend buy signal afterthe swing low at point D. That signal ultimately failed after 12 days, and the trend changed to adowntrend. In the FTSE index, I define a failed signal as one that has not moved 100 points inmy favour i.e. about 1.7 - 2%.55
Marc Rivalland on Swing Trading
There seems no point in displaying charts of these occasions. I have not found that they haveanything particular in common which would be instructive.In addition to the false starts described above and the spring trap reversals described below, in1999 the FTSE had 2 failed signals out of a total of 25 signals, in 2000 5 failed signals out of atotal of 26, and in 2001 3 failed signals out of a total of 20 signals.Whereas a failed signal ‘works’ for a few days, without generating any worthwhile profit, beforethe market has second thoughts, any signal which effectively does not work at all is a falsesignal. Here are the notable ones:Intraday reversals
The market advances through a swing high suggesting a change a trend. In fact, later the sameday it reverses, which makes it look very much like a swing high is being completed rather thana change in trend. So the breach of the old swing high was a false buy signal. The close shouldbe very weak to confirm this as an intraday reversal. Look at the chart opposite which showsBT in September 1998.1.
On 16th September a 3 day rally creates a swing high at 595p.
2.
By 23rd September another 2 day rally has taken BT all the way back to a high of 595p.
3.
On 24th September, BT opens at 589p but powers through the swing high of 595p,indicating a change in trend. Allowing for 0.5% slippage, you might place a stop buyorder at 598p. The stop is hit, but the high of the day is 599p (although it could have been602p, 610p or 620p for the purposes of this example). Later that day the stock reversesand by the close, it looks as if it is establishing a swing high rather than a change in trend.
A stop loss to exit the position could have been placed at 581p on the basis that that point wouldrepresent an outside day reversal. The share should at the very latest have been sold on the closeat 562p. The share could also have been shorted on the close. It was indeed making a swing high,and it subsequently fell to 462p.Note Although you will see these intraday reversals, and they will cost you money, thisparticular trade was easy to avoid. I have shown it purely as a good example of the intradayreversal. In fact the FTSE was in a clear bear market as a result of the Russian debt default, andit had rallied on 22nd and 23rd September. It seemed very likely that the FTSE was about tocomplete a 3 day swing high on 24th September (which is what it did). All one needed to do wasto wait and see whether the FTSE itself breached its previous swing high (in which case onecould buy one of its leading components BT) or whether, as was more likely, the bear trendwould continue. There was no need to jump the gun by buying BT on the apparent breach of theswing high. Hindsight, I hear you say. Not a bit. See Chapter 10 on the benefits of crosschecking. This is a prime example of it.56
Modified Swing Charts
FalseBuy Signal3
1
2
fig 4.15Spring Trap Reversals
I was sure I had a book in my study by an American author which described one of his favouritereversal patterns as the Spring Trap Reversal, but I’ve been unable to find it, and therefore togive credit for it. In any event the genesis of this signal is clear enough. Richard Wyckoff wroteabout technical analysis at roughly the same time as W.D. Gann. One of the chart patterns whichhe highlighted was the ‘spring’ which occurs when a falling market breaches a support level, buteither the same day or the next day rallies back above the support level. If it does so the sameday, it is an intraday reversal, as described above. The opposite of the spring is the upthrustwhich occurs when a rising market breaches resistance, only to fall back below the resistancewithin a short space of time.57
Marc Rivalland on Swing Trading
The spring trap reversal is merely a type of Wyckoff spring/upthrust. It is similar to the intradayreversal, except that there is no indication on the day of the signal that anything is amiss. Theclassic spring trap reversal occurs the day after the swing chart buy or sell signal. Again themarket is having second thoughts. There is in fact no new consensus developing about a changein trend.
1Sell
2 3
fig 4.161.
The FTSE swing low is made on 26th April 2001 at 5777, and the same day the marketgives a buy signal as it rallies through the high of the previous day (5841).
2.
The move to new highs validates the putative swing low, but not much progress is made.In my style of trading (see Chapter 5), you would have taken half profits on your long
58
Modified Swing Charts
position at 5991, and you would have been stopped out of the remainder of your positionat the entry point on 3rd May. The same day the FTSE plunges through the swing lowsof 5777. The impression of a change in trend is reinforced by the very weak close, hardon the lows of the day.3.
The following day the market opens a fraction higher, and then moves lower than theprevious day but only by 1 point. After the weak close, following a sell signal, oneexpects a more substantial downside follow-through. The market rallies all day and closeson the highs of the day. The daily range (difference between high and low) is aboveaverage. The breach of the swing lows the previous day was a trap, as I noted on the website I was writing for at the time.
Variations on the spring trap reversal
Look at the chart for FTSE in January 1999.
4
2
1
3
Sell
Swing Low
fig 4.1759
Marc Rivalland on Swing Trading
1.
On 15th January the FTSE makes a swing low at 5737. The subsequent upward swingfalls short of the early January highs.
2.
On 25th January the FTSE makes a fresh swing low at 5749, but again the subsequentupward swing falls short. FTSE is making an irregular pennant.
3.
On 10th February the FTSE opens at 5780. Sustained selling takes it clean through bothswing lows down to 5698. A clear sell signal. Yet it rallies a bit by the close. At this point,one’s brow furrows a little, but one can’t be frightened out of a trade simply by this oneunhelpful close.
4.
The next day, the reversal keeps going. Even at this stage, I am loathe to close out thetrade. The market does manage to shake out weak holders in this fashion. But by the closeI no longer need convincing. Throw in the towel.
I don’t want to make too much of these false signals. You should not be frightened out of a tradeat the first whiff of grapeshot. If in doubt, hold the position with your stop in place.
False spring trap reversals
If the spring trap reversal describes a false move, this is a false false move. Happily they arevery rare beasts. This is the only clear example I could find in the FTSE index. Take the FTSEchart for May/June 1999, part of which I considered on page 33.1.
The market rallies 445 points in 4 days making a very clear swing high on 23rd May. Asit falls below the previous days low, it generates a clear sell signal. The sell signal isvalidated by the fact that the market makes new lows. Once again half profits of 150points would have been taken.
2.
31st May. First up day. Stopped out of remaining half short position at the entry point.
3.
1st June. Inside day. Ignore.
4.
2nd June. Second up day.
5.
3rd June. Outside day with higher close. Counts as an up day. From this point, the swingtrader is alert for a new sell signal, but the market continues to rally. Each day the stopsell order is moved up to underneath the previous days lows. But the sell order is neveractivated.
6.
On 7th June, the market rallies straight through swing high of 23rd May at 6462. Buy at6463 stop. There is no follow-through that day. Market closes at 6432, which is not goodbut not worrying as yet.
7.
8th June. Market does edge a little higher, and closes at 6453, but still no follow-through.
60
Modified Swing Charts
9
Buy
6 7
1
4 5
2
8Looks like aspring trap reversal,but isn’t
3
fig 4.18
8.
9th June. Down day with expanding daily range, closing near the lows of the day. Springtrap reversal. Sell at 6403 for 60pt loss.
9.
10th June. What!! Deeply unsporting. Market zooms ahead as if there never had been anycause to fret. Re-establish longs at 6470 with stop loss below lows of 9th June. Powerfulfinish to the day. Uptrend re-affirmed. Even then the market gives you a scare the verynext day but the stop loss holds, and the market goes on to rally to 6614.
61
Marc Rivalland on Swing Trading
TailpieceThe response I’ve had from the seminars I have given has been enthusiastic, although some havesaid that they found it a bit complicated. It can seem complicated because it is new. But swingcharting is simplicity itself. Practise by back testing the principles on the market you followmost closely. Do not be put off by spring trap reversals which I have included for the sake ofcompleteness. They are rare. They probably happen about once a year on average. You couldentirely ignore the concept of spring trap reversals - simply hold your position with a 2.5% stoploss in place, and you won’t need to worry about what is or is not a spring trap reversal. Thisapproach may cost you a bit more money, but you will fret less.The only really tricky part of my modified swing charts is distinguishing between a falsestart/complex swing and a change of trend, when the market spends just 2-4 days above theputative swing low and then crashes through it (vice versa for swing high).As I mentioned on page 55, my rule of thumb is that if the market has spent 3 days above its swinglow, and crashes through on the fourth day, it’s a change of trend. That is easy enough. Butfrustratingly it can and does happen that the market spends 2 full days above its swing low and thebest part of the third day above it as well, only to crash through the swing low right near the closeof the third day. Now what? Does one stick rigidly to the rule of thumb? The answer is no, norigidity. Intermarket cross checking, and looking at other indicators, such as (but not necessarilyconfined to) point & figure charts, usually clarifies the position. I explain this in the next chapter,and in Chapter 9. But I accept that it is a tricky part of the analysis. I like a challenge.In analysing swing chart signals, I always use the true daily high and low of the FTSE 100 index.The LSE’s opening auction renders the initial index readings meaningless. When making theFTSE index calculation at 8.00.00, the LSE uses the closing price of the previous day of eachshare, and continues to use it until that share uncrosses in the auction. The result is that theopening prints of the FTSE index, as disseminated by the LSE, are always wrong (if what youare looking for is the true opening level of all the constituents of the FTSE index). If the openingprint is also the high or low of the day, the reported high or low of the FTSE index will also bewrong. Most data vendors will simply report whatever they receive from the LSE. There are atleast two sources of “correct” information. The Financial Times newspaper (not the website)publishes the high and low by excluding the first three minutes of index calculations. I havetracked this data and it is very accurate. And www.moneyam.com publishes the same data. Ifyou are in any doubt look at the FTSE chart on www.moneyam.com. You could also use thefutures high/low as a guide. As regards the Dow, I use the futures high/low between 2.30pm and9pm, adjusting for the cost of carry, as a proxy for the real index high/low.Some traders have expressed to me their dismay at having to use the true high and low, ratherthan the high and low provided by their data vendors. It is not compulsory to use the true highand low. Backtesting will reveal that my method of swing charting works perfectly well evenusing the adulterated data, but very occasionally an opportunity might be missed (like thebeautiful FTSE linear phase sell signal which occurred on 2 July 2002).62
5
SWING CHARTING T