Swing Trading and Short Term Price Patterns

Author: Linda Raschke

Swing Trading Technique

Swing trading is learning how to enter trades with minimal risk and manage positions according to the markets' subsequent behavior.  It does not try to predict an outcome in the same way pattern recognition does.  The last piece of information the market gives us is the one from which we are going to make our next decision.  Here is the type of information we are interested in:

1) Is the market is making a higher low or lower low? A higher low confirms support.

2) How much higher or lower is the next low? The distance between these two points indicates your degree of trend.

3) What is the length of the last swing relative to the previous swing? A short swing precedes a reversal.  Longer swings signal to enter on retracements.

These same rules apply to all time frames.  The classic rule on volume and open interest also apply as increasing volume/open interest confirms a swing and decreasing volume/open interest signals a reversal.  Swing trading is following the market's most probable course of action and sticking to the rules.  The first objectives are trading on tests of previous highs/lows. When buying a lower low, exit more quickly.  There is no confirmed support.  Conversely, when selling a higher high in a uptrend, buy the retracement.  In an uptrend, expect tests of the lows to be higher tests and for the highs to penetrated.  Just as we enter on tests of lows/highs, we look to exit on the tests in the other direction.  We look to exit in the direction of our swing, before the price reverses.  If the market does not do what is expected, exit on the first opportunity.  This is important.  Risk should be defined by the last swing point.  Always define your risk before entering a market.  Never average a losing position.  Never add a second position the short side.  Downtrend swings tend to sharper and faster than uptrend swings.  Lastly, if the market loses its swings or if they are small, don't trade.

Short Term Trading Tendencies

The markets tend to trend in one direction for the day.

Most reversals are made in the morning (NY times), not in the afternoon.

Lower closes forecast lower prices 85% of the time.

Afternoon strength or weakness will have follow through the next day. The exceptions to this are the larger range climax days.

Prices tend to reverse every 2 1/2 days.  The exception to this is a breakout from a critical point or extreme contraction.  Then expect the market to run 5-6 days.

Buy the first pullback after a new high.  Sell the first rally after a new low.

Failure to take out a new high then warrants a short sale.

The larger the market gaps, the greater the odds of continuation.

Morning moves catch their breath at lunch time (NY Times).

Swing Trading Glossary

Chaos Theory - the study of nonlinear, dynamic systems.  The market is a dynamic feedback system which is not predictable in the long term as there are too many variables.  Feedback systems are when what happened yesterday will influence what will happen today.

Complex Systems - have the three main characteristics: 1. They are dynamic. 2. Contain critical levels 3. Have a certain level of noise (negative feedback).

Positive Feedback (Deterministic Chaos) - a condition in which short, intermediate, and long term cycles/momentum become self reinforcing loops, creating a positive gain at each stage.  This can create runaway markets.

Critical Point - a pivot point formed by the meeting of two different time frame .  Unpredictable, erratic, or sometimes explosive price action can follow as the market continues along the short term trend or reverses along the longer term trend.  When the market loses its oscillations (and the absolute mean deviation approaches zero, the market has reached a fragile equilibrium state.  When the market moves oft of the point, it pulls the short and intermediate term cycles up or down together, creating a condition call positive feedback.

Negative Feedback - a condition in which the market becomes more sensitive to external influence and outside noise.  It is usually in a corrective or consolidating mode. The shorter the trading horizon, the greater the complication noise presents, but usually ideal swing trading conditions set up.

Fractal - Patterns that exist on a small scale are replicated on larger scales. Each part of a fractal is related to eh whole.  Risk reward is an important fractal statistic.  Thus, your personal risk tolerance should be the governing factor in which time frame you trade on.  There are no optimal parameters, only probabilities which can change abruptly at critical points.

Double stop point - a place where the market has set up a successful test setting up two support or resistance points.  Never risk below a double stop point.

About the author:

Linda Bradford Raschke is an independent trader and president of LBR Group Trading Co, a private firm specializing in money management.  Beginning in 1981, she spent six years trading equity options on the floor, first at the Pacific Coast Stock Exchange and the Philadelphia Stock Exchange.  She began trading the S&P500 when it was first listed as futures market.  In 1987 Linda left the trading floor to concentrate on trading futures only.  However, she continued her 16-year study of technical analysis and price behavior, developing proprietary trading tools, methodologies, and systems based on her floor-trading experience.  In 1993, she and Steve Moore formed LBR Moore Trading , Inc., a firm specializing in research and educational training tools,  LBR Moore not only quantified and systematized many of Linda's original trading ideas and techniques but has also developed some unique indicator new to technical analysis.  Linda continues to teach traders how to trade and is actively involved in presenting trading workshops and online seminar for companies such as the MarketClub Trading Service.