1. Linda Bradford Raschke
2. Stan Weinstein’s Secrets for Profiting in Bull and Bear Markets
3. Common knowledge of any market condition closes the system inefficiency that allows easy profit from it. Triangles, flags, and double tops now belong to the masses and are often undependable to trade through old methods.
4. Fortunately, the popularity of chart reading opens a new and powerful inefficiency for swing traders to manipulate. They can use the crowd’s limited pattern knowledge for their own profit. The new disciples of technical analysis tend to focus on those few patterns that have worked well over the past century. Skilled traders can place themselves on the other side of popular interpretation and fade those setups with pattern failure tactics. More importantly, they can master the unified structure that underlies all pattern development and awaken the skills required to successfully trade dependable setups that have no name or adoring crowd.
5. Prices trend only fifteen to twenty percent of the time through all equities, derivatives, and indices. This is true in all charts, from 1-minute bars through monthly displays. Markets spend the balance of time absorbing instability created by trend-induced momentum. Swing traders see this process in the wavelike motion of price bars as they oscillate between support and resistance.
6. This interface between the end of an inactive period and the start of a new surge marks a high-reward empty zone (EZ) for those that can find it. The EZ signals that price has returned to stability. Because only instability can change that condition, volatility then sparks a new action cycle of directional movement. Price bars expand sharply out of the EZ into trending waves
7. Swing traders use pattern recognition to identify these profitable turning points. Price bar range (distance from the high to low) tends to narrow as markets approach stability. Skilled eyes search for a narrowing series of these bars in sideways congestion after a stock pulls back from a strong trend. Once located, they place execution orders on both sides of the EZ and enter their position in whatever direction the market breaks out.
8. Paradoxically, most math-based indicators fail to identify these important trading interfaces. Modern tools such as moving averages and rate of change measurements tend to flatline or revert toward neutral just as price action reaches the EZ trigger point. This failure reinforces one of the great wisdoms of technical analysis: use math-based indicators to verify the price pattern, but not the other way around.
9. Volatility provides the raw material for momentum to generate. This elusive concept opens the door to trading opportunity, so take the time to understand how this works.
10. Tony Crabel’s classic study of range expansion, Day Trading with Short Term Price Patterns and Opening Range Breakout, predicts volatility through patterns of wide and narrow price bars.
11. We must understand the complex mechanics of the trend-range axis:
• Price movement demonstrates both directional trend and nondirectional range.
• Range motion alternates with trend movement.
• Trends reflect a state of positive feedback where price movement builds incrementally in a single direction.
• Ranges reflect a state of negative feedback where price movement pulses between minimum and maximum points but does not build direction.
• Trends reflect an upward or downward bias.
• Trends change and reverse at certain complex points of development.
• Ranges reflect their repeating patterns, bias for continuation or reversal, and the trend intensity expected to follow them.
• Movement out of ranges continues the existing trend or reverses it.
• Range volatility peaks at the interface between a trend climax and the inception point of a new congestion pattern.
• Range volatility ebbs at the apex point just prior to the inception of a new trend.
• High range volatility = wide range bars, high volume, and low price rate of change.
• Low range volatility = narrow range bars, low volume, and low price rate of change.
• Congestion pattern breakouts reflect a shift from negative feedback to positive feedback.
• High volatility associated with the end of positive feedback induces nondirectional price movement.
• Low volatility associated with the end of negative feedback induces directional price movement.
• Negative feedback registers on oscillators as shifts between overbought and oversold states but does not register on momentum gauges.
• Positive feedback registers on momentum indicators as directional movement but gives false readings on oscillators.
Pattern Cycles organize trading strategy along this important trend-range axis. When breakouts erupt, follow the instincts of the momentum player. Buy high and sell higher as long as a greater fool waits to assume the position. But quickly recognize when volume falls and bars contract. Then focus to classic swing trading tactics and use price boundaries to fade the short-shift direction.
Markets alternate between directional trend and congested range through all time frames. After a rally or selloff, stability slowly returns as a new range evolves. This quiet market eventually offers the right conditions for a new trend to erupt. Notice how the end of each range exhibits a narrow empty zone interface just before a new trend suddenly appears to start a fresh cycle.
Price seeks equilibrium. When shock events destabilize a market, countertrend force emerges quickly to return a stable state. This inevitable backward reaction follows each forward impulse. Novices fail to consider this action-reaction cycle when they enter momentum positions. They blindly execute trades that rely on a common but dangerous strategy: long side entry on an accelerating price thrust. Reversals then appear suddenly to shake out the weak hands. The typical momentum player lacks an effective risk management plan during these sharp counter-trends and tries to exit with the herd. Bids dry up quickly on the selloff and force an execution well below the intended price.
The momentum chase chews up trading accounts during choppy markets as well. This popular strategy requires a strong trending environment. As noted earlier, periods of directional price change last a relatively short time in relation to longer sideways congestion. But rather than stand aside, many participants fall prey to wish fulfillment and see trends where they don’t exist. They enter small price swings on the false assumption that the action represents a new breakout. While these errors may not incur large losses, they damage equity and confidence at the same time.
Momentum vs. Swing Characteristics
Trade Momentum Swing
State: Positive feedback Negative feedback
Strategy: Reward Risk
Basis: Demand Supply
Chart: Trend Range
Impulse: Action Reaction
Purpose: Thrust Test
Condition: Instability Stability
Indicator: Lagging Leading
Price Change: Directional Flat-line
Trend-range alternation spawns different trading styles. When markets ignite into rapid price movement, skilled momentum traders use the crowd’s excitement to pocket large gains. The inevitable rollover into defined support and resistance marks the dominance of precise swing trading techniques. But neither category actually stands apart from the other. The need to adapt quickly to changing market conditions requires that all successful traders apply elements of both strategies to earn a living.
Successful trade execution aligns positions through a multidimensional time view. First choose a primary screen that reflects the holding period and matching strategy. Then study the chart one magnitude above that period to identify support-resistance and other landscape features that impact reward:risk. Finally, shift down to the chart one magnitude below the primary screen and identify low-risk entry points. This multidimensional approach works through all time levels. Even mutual fund holders can benefit when they locate a potential investment on a weekly chart but use the daily and monthly to time entry to the highest probability for success.
Swing traders must always operate within this 3D trend relativity.
Market participants routinely fail at time management. Many never identify their intended holding period before they enter a trade. Others miss major support-resistance on the daily chart when they execute on the 60-minute bars. Some sit on nonperforming positions for weeks and tie up important capital while excellent opportunities pass by. In all cases, time works as efficiently as price to end promising careers.
Time of day, week, and month all display unique properties that enhance or damage the odds for profit. Market insiders use the volatility of first-hour executions to fade clean trends and empty pockets. Options expiration week can kill strong markets or force flat markets to explode. Thin holiday sessions offer dramatic rallies or selloffs in the most unexpected issues. And many Fridays begin with government statistics that ignite sharp price movement.
Few executions align perfectly with the charting landscape. Successful trading requires a careful analysis of conflicting information and entry when favorable odds rise to an acceptable level. When faced with a good setup in one time frame but marginal conditions for those surrounding it, use all available skills to evaluate the overall risk. If reward:risk moves into a tolerable range, consider execution even if all factors do not favor success. That’s the nature of the trading game.
Support-resistance priority parallels chart length. Use this hierarchy to locate high-probability entry levels and avoid low-reward trades. For example, major highs and lows on the daily chart carry greater importance than those on the 5-minute chart. As the shorter bars drift down toward the lows of the longer view, strong support exists for a significant bounce. These 3D mechanics also suggest that resistance in the time frame shorter than the position can safely be ignored when other conditions support the entry.
Profit opportunity aligns to specific time frames. But many participants never clearly define their targeted holding period and trap themselves in a destructive strategy flaw. They see their trades in one time frame but execute them in another. This trend relativity error often forces a new position just as the short-term swing turns sharply against the entry. Neophytes fall into this trap with great frequency. They feel pride when they see an impending move on their favorite chart and recklessly jump on board. The action-reaction cycle then kicks in and shakes them out as price tests support before heading higher.
Most players should never change their holding period without detailed preplanning. Specific time frames require unique skills that each swing trader must master with experience. This noble effort should not begin trying to rescue a loser from bad decision-making.
Compensate for this mental bias through precise trade management. Begin with a sharp focus on the next direct move within a predetermined time frame. Prepare a written trading plan that states how long the position will be held and stick with it. Establish a profit target for each promising setup and then reevaluate the landscape that price must cross to get there. Consider the pure time element of the trade. Decide how many bars must pass before a trade will be abandoned, regardless of gain or loss.
Volume rarely reveals accumulation-distribution in a straightforward manner. Bursts of emotional buying or selling may dictate price direction over short periods of time, regardless of the underlying trend. Effective longer-term analysis requires filtering mechanisms to distinguish between these pockets of frantic volatility and significant participation that will eventually guide prices higher or lower.
A hidden spring ties together volume and price change. Accumulation-distribution may lead or lag trend. As one force steps forward, tension on the spring increases. The leading impulse pauses until a release point strikes and the other surges to join its partner. This tension measurement between price and volume offers an important signal for impending market movement. Since positive feedback requires synchronicity between both elements, volume leadership predicts price change.
Cross-market influences shift between local and worldwide forces. During quiet periods, simple arbitrage generates primary influence. But world events or broad currency issues may rise to the surface and shock American markets. Always defend active positions by staying informed and planning a safe exit in the case of an emergency. Avoid overnight holds during very volatile periods and think contrary at all times. The best opportunity may come right after the crowd jumps for the exits.
Follow the charts of the major indices and S&P futures on a daily basis. Intraday traders should watch their real-time movement throughout each session. Keep track of the current bond yield and identify major support-resistance levels. Identify market leadership as early in the day as possible. Then use that price action to predict the short-term flow of the market. When a macroeconomic event appears, consider taking the day off unless a clear strategy emerges to capitalize upon it.
Always remember this valuable wisdom: attention to profit is a sign of trading immaturity, while attention to loss is a sign of trading experience.
Show a willingness to forgo marginal positions and wait for good opportunities to appear. Prepare to experience long periods of boredom between frantic surges of concentration. Expect to stand aside, wait, and watch when the markets offer nothing to do. Accept this unwelcome state as all successful participants do. The need for excitement makes a very dangerous trading partner.
Careful stock selection controls risk better than any stop loss system. Bad timing does more damage than sustaining large losses. Make wise choices before position entry and face less risk at the exit. Watch out for secondary gains that have nothing to do with profit. Trade execution will release adrenaline regardless of whether the position makes or loses money. Always face your true reasons for swing trading the markets. The primary motivation must be to aggressively take money out of someone else’s pocket. Rest assured, the skilled competition will do their best to take yours at every opportunity.
Every setup has a price that violates the pattern. The measurement from this breach to the trade entry marks the risk for the position. When planning execution, look for levels where price must move only a short distance to show that the trade was a mistake. Then expand this measurement to find the reasonable profit target and apply this methodology to every new opportunity. Limit execution to positions where risk remains below an acceptable level and use profit targets to enter markets that have the highest reward:risk ratios.
Both negative and positive feedback conditions produce rewarding trades, but confusion between the two can lead to major losses. Classic swing strategies work best during negative feedback, while positive feedback supports profitable momentum entry. Avoid the danger of choosing the wrong strategy through consistent application of the expanded swing methods. Regarding of market phase, use this simple, unified approach for all trade executions: enter positions at low risk and exit them at high risk. These mechanics often parallel the buying at support and selling at resistance exercised in classic swing tactics. But this expanded definition allows entry into the realm of the momentum trader with safety and precision.
Swing trading allows many methods to improve profitability. Try to adjust position size, manage time more efficiently, or slowly scale out of winners to retain a piece for the next price thrust. But careful trade selection does more to build capital than any other technique. Enter new positions only when signals converge and send a clear message. Standing aside requires as much careful preparation as entry or exit and must be considered before every execution.
Use technical analysis and drill swing prices into memory. Target acceptable dollar and tick losses. Remember that the average position gain must be significantly higher than average loss or survival will depend upon a winning percentage well above 60%. Improve results by reducing losses first and increasing profits second. Keep current and accurate trading records. The mind will play cruel tricks when results depend on memory.
Consider the real impact of available capital and leverage. The well-greased competition can overcome their transaction costs by trading large blocks. But small equity accounts must watch trade size and frequency closely. Frequent commissions and small capital will eventually end promising careers in speculation. When trying to grow a small account, lengthen holding period and go for larger profits per entry. And use any drawdowns as a major signal to lighten up and slow down.
Apply a simple hierarchy that rates the importance of each S/R (Support-resistance) feature. Horizontal levels that persist over time carry more weight than those from shorter periods. Major highs and lows provide stronger S/R than moving averages or other price derivatives. Hidden levels offer cleaner opportunities than well-known ones that invite whipsaws and fading strategies. S/R strengthens when many barriers converge at the same price and weakens when a single obstacle blocks the progress of price movement.
Look for price to fail the first test of any significant high or low horizontal S/R level. But then expect a successful violation on the next try. This classic price action has the appearance of a triple top or bottom breakout. The popular cup and handle pattern offers a clear illustration of this dynamic process. Also watch closely where the first test fails. If price cannot reach the horizontal barrier before rolling over, a second test becomes unlikely until the pattern breaks sharply in the other direction.
Rising or falling moving averages routinely mark significant boundaries. The most common calculations draw lines at the 20-day, 50-day, and 200-day moving averages. These three derivative plots have wide acceptance as natural boundaries for price pullbacks. Two important forces empower these classic averages. First, they define levels where profit and loss taking will ebb following strong price movement. Second, their common recognition draws a crowd that perpetrates a self-fulfilling event whenever price approaches.
The S/R character of moving averages changes as they flatten and roll over. The turn of a specific average toward horizontal signifies a loss of momentum for that time frame. This increases the odds of a major line break. But don’t confuse this condition with an extended sideways market in which several averages flatline and draw close to each other. In this dead market, price will most likely swivel back and forth repeatedly across their axis in a noisy pattern. Swing traders find few opportunities in this type of environment.
Trendlines and channels signal major S/R in active markets. Look for three or more points to intersect in a straight line. Then extend out that trendline to locate important boundaries for price development. As with other landscape features, long-term lines have greater persistence than shorter ones. Strong trendlines may even last for decades without violation.
Many swing traders assume that violation of a trendline or channel signifies the start of a new trend. This is not true and leads to inappropriate strategies. Trendline breaks signal the end of a prior trend and beginning of a sideways (range-bound) phase. A market can easily resume a former trend after it returns to stability. Shock events that combine with line breaks can start immediate trends in the opposite direction, but these happen infrequently. Hole-in-the-wall gaps (see Chapter 11) provide a powerful example of this phenomenon.
Trendline and channel breaks should induce immediate price expansion toward the next barrier. When this thrust does not occur, it can signal a false breakout that forces price to jump back across the line and trap the crowd. Whipsaws and pattern failures characterize modern markets. As common knowledge of technical analysis grows, insiders routinely push price past S/R just to trigger stops and volume. These gunning exercises end only after the fuel runs out and induces price to drop quietly back into its former location.
Mathematical statistics of central tendency study the esoteric realm of divergence from a central price axis. Analysts use these calculations every day as they explore standard deviation of market price from an expected value and its eventual regression back to the mean. Broad concepts of overbought and oversold conditions rely on proper measurement of these complex variables. Swing traders depend on this arcane science to identify powerful standard deviation resistance through Bollinger Bands and other central tendency tools.
Central tendency provides excellent trading opportunities but take the time to understand its mechanics. Extreme conditions often last well beyond expectations and shake out contrary positions. They may trigger trend relativity errors when elastic extremes don’t line up through different time frames. This powerful tool supplements other classic pattern and S/R easurements but doesn’t replace them. Use central tendency to uncover ripe trading conditions but then shift to other indicators to identify low-risk entry levels and proper timing.
Volume establishes important S/R boundaries. When markets print very high volume, they undergo significant ownership change that exerts lasting influence on price development. The frantic event may occur in a single bar or last for several sessions. The volume action must rise well above that issue’s historical average in either case. These power spikes invoke special characteristics that may yield frequent trading opportunities. But the event will leave a long-lasting mark on the charting landscape whether or not it produces an immediate profit.
Crowd accumulation and distribution (acc-dis) define hidden volume boundaries. Buying or selling pressure often leads price development. When acc-dis diverges sharply in either direction, price will routinely thrust forward to resolve the conflict. Divergence itself induces the S/R mechanics. For example, a stock may drop sharply but remain under strong accumulation as it falls. The buying behavior not only slows the decline but also signals that the issue will likely print major support and bounce quickly.
Fibonacci math works through crowd behavior. A rally builds a common structure of participation. When it finally ends and starts to unwind, shareholders try to predict how far price might fall before the underlying trend resumes. The unconscious mind first sees the proportional one-third retracement as a good reversal point. New buyers do emerge here, but the subsequent bounce often fails and the issue falls through the prior intermediate low. This terminates the crowd’s greed phase and begins a period of reason. The concerned eye now sees the halfway retracement as support and the issue again bounces on schedule.
Pullbacks can strike diverse S/R boundaries at any time and shift direction. But corrections routinely retrace at least one-third to one-half before support begins a new rally phase. Many active trends pull back all the way to two-thirds before the primary direction reasserts itself. These deep dips have a strong effect on the crowd. The break of halfway support terminates reason and awakens fear. The threat that the prior trend will completely reverse triggers sharp selling through this last level until a final shakeout ends the decline.
Modern markets hide boundaries more esoteric in nature than retracement science. Round numbers affect trend development through all time frames. S/R intensity increases as zeros add onto price. For example, stocks that approach 100 face more significant resistance than those that reach under 10. Whole number S/R tends to peak according to multiples of 10. In other words, 10, 20, 30, etc. represent natural barriers. And look for further S/R at divisors of 10 such as 5, 15, and 25.
High-volume events often deplete the available crowd supply and trigger important reversals.
Cross-verification searches the charting landscape to locate the primary sign-posts of trading opportunity. Common sense dictates that multiple crowd influences favor certain price levels over others. Swing traders can identify these setup intersections when they uncover those points where different S/R types and time frames converge with each other. For example, a single level that points to a major high, a 50% retracement of a larger trend, and the 50-day moving average strongly implies that certain important events will occur when price strikes that point.
Focus trade preparation on cross-verification to locate promising setups and measure reward:risk. Look for price close to substantial support to identify low-risk long trades. Look for price close to substantial resistance to find low-risk short sales. Measure the distance between the entry and the next barrier within the holding period for the trade. This points to the intended exit and reasonable profit target (PT). Measure the distance between the entry and the price that confirms that the setup was wrong. This points to the unintended exit and reasonable failure target (FT). Execute only those trades with high PT and low FT distance.
Not sure how long to maintain a position? Most swing traders should choose a specific holding period that reflects their lifestyle and not change it until thoughtful planning presents an alternate strategy. The rational mind will turn poorly defined time frames into major losses. Trades become investments and ex-traders become humbled investors. As strategies evolve, slowly experiment with different time frames. During these phases, prepare to answer the time question clearly before each trade execution. Write it down and stick to it or success will not come easily.
Holding Period and Chart Correlation
Trade Type Holding Period 3D Chart Combination
Scalpers Seconds to minutes 1-minute 5-minute 15-minute
Day traders Minutes to hours 1-minute 5-minute 60-minute
Position traders Hours to days 60-minute daily weekly
Investors Days to weeks Daily weekly monthly
Institutions Weeks to years Weekly monthly yearly
Toggle between arithmetic (linear) and logarithmic (geometric) charts frequently. Log charts examine percentage growth. Stick with log charts for lowpriced stocks or stocks that experience significant price change over short periods of time, and rely on linear charts for higher-priced or slower-moving stocks.
Information panes below price bars serve a single purpose: to assist the investigation of the top pane. Use indicators to support the pattern analysis and not the other way around. Above all else, technical analysis is a visual art. Always start trade preparation with a peek at the price bars first. If something catches your eye, then check the lower pane to find out whether it confirms or refutes the observation.
Markets give away their secrets to swing traders who take the time to look carefully. Building a detailed landscape on each chart reveals trend and pattern powerpoints where important crowd forces will converge. These focused time/price zones target the hidden points primed for reversals and breakouts. When the participant has a clearly defined plan of what to do when price hits one of these hot spots, they’ve learned the art of swing trading.
Develop precise visual skills and don’t rely on a toolbox of complex math-based indicators. Swing trading teaches discretionary execution based on convergence of time and price but does not require mechanical models or systems. Realize that most indicators arise from very simple building blocks.
Build the charting landscape with moving averages (MAs). These classic momentum tools define both trend and natural pullback levels. Use them in all charts through all time frames. MAs respond to specialized settings that reflect the prevailing crowd within any holding period. So take great care to choose appropriate values. Averages must align with the current swing trading strategy or they will generate poorly timed executions.
Moving averages provide highly visual information as they interact directly with price. Indicators that fit into a separate lower pane force the eye to filter out large quantities of noise to manage information. Unfortunately, the filtering process also discards important data. Moving averages emit continuous signal without noise because they plot within the price pane.
Identify convergence-divergence between price and MAs. Because price always moves toward or away from an underlying average, each new bar or candle uncovers characteristics of momentum, trend, and time. This same process works just as well in relationships between two or more MAs. For example, the classic MACD.
Use exponential moving averages (EMAs) for longer time frames but shift down to simple moving averages (SMAs) for shorter ones. EMAs speed and smooth the action as they give more weight to recent price change. SMAs view each data point equally. Good intraday signals rely more on understanding how the competition thinks than they do on the technicals of the moment.
Swing traders access a powerful information tool when they add multiple MAs into 3D charts and build a complete multi-time frame trend system. Tie these MA ribbons (MARs) together through a mathematical relationship that mimics time. One classic combination for a daily chart utilizes 20, 50, and 200 periods. Notice how each segment approximates three to four times the preceding one. These ratios tend to narrow in the shorter intraday averages, but the purpose remains the same. They provide an effective framework to investigate and trade three distinct periods of trend: short, intermediate, and long-term.
MA ribbons emit continuous trend feedback. For example, they signal a bear market when they flip over on the daily and the 200-day MA stands on top. The bull reawakens when the shorter averages cross back above the longer ones and each lines up in order again. Expect choppy price action during phases when the averages criss-cross out of sequence.
Use standard settings of 20-50-200 for the daily time frame or speed them up to 18-50-150 for an aggressive view. Popular daily averages provide an easy framework for quick digestion of a large number of stock charts. Watch them to measure the opposing crowd. Focus on the common belief that short-term trends pull back to the 20-day MA while intermediate and long-term impulses find support at the 50- and 200-day MAs.
Trending markets echo characteristic price behavior over and over again. Measure this fractal fingerprint in the depth that an issue corrects after each impulse of a trend. MARs allow quick examination to locate classic retracement levels to use for entry on the next pullback. These can be very pleasant times for swing traders. Watch closely how price penetrates the ribbon. The depth it reaches before emerging often reflects a level that the trend will repeat over and over again. When price undergoes a sudden shift in direction, ribbons twist and mark clear signposts for awakening volatility. Each of the averages requires a different time period to absorb price change and roll over. This emits a broad range of rainbow patterns that have obvious predictive power.
MARs slowly invert to accommodate changing conditions as price shock induces a new trend. Manage positions using these visual interrelationships. Execute short-term swing trades when risscross MARs predict pivoting price movement. Once inversion completes, shift to momentum entry that takes advantage of the new convergent environment. Spreading MARs signal accelerating momentum when layered through adjacent time periods.
Act only on candles that print with length and volume both well above the average of the previous bars and those precisely located at major S/R pivots. Avoid all signals based on patterns in low-priced or thin issues.
Candlesticks illustrate reversal patterns better than any other technical tool. Candlesticks work well in conjunction with Bollinger Bands and other central tendency tools. Look for reversal patterns when price pushes outside of the top or bottom band.
Bollinger Bands (BBs) focus analysis of central tendency in real-time. As markets evolve, this powerful tool draws upper and lower channels that predict extremes based on price’s relationship to the most recent action. To use the bands effectively, apply a central moving average that tunes into the expected holding period. Choose this important value carefully. Longer averages will lead to later signals, while shorter ones will generate whipsaws.
Most charting programs default to the popular 20-bar, 2 std dev settings. Pull up this common view frequently to eavesdrop on how the crowd views its positions. This standard BB promotes simple tactics that align to common herd reactions. Enter fade positions when price strikes horizontal top or bottom bands that hold firm after the collision. Look for bands to tighten around a dull market in expectation of a sharp breakout move. In active markets, congestion often forms as price nears the center band and persists until bars expand sharply through the barrier or reverse in a failure. Enter positions in the direction of the expansion or place entry stops at both extremes of the congestion. Consider new short sales when price pops more than 50% out of the top band and new longs after the same violation of the bottom band.
Swing traders require faster signals than investors. Consider a 13-bar, 2 std dev setting for most intraday charts. This more sensitive input captures trend activity and breakdown better than the 20-bar. All BBs work best in combination with other moving averages placed over the bands. Add 5-bar and 8-bar SMAs to create a 5-8-13 combination. This Fibonacci number set consistently picks up major intraday swings and reversals. Use the 5-bar for S/R on dynamic trends, the 8-bar for pullbacks, and the 13-bar to locate trend change and reversal.
Bollinger Bands identify subphases within the current trend. Price enters a bull phase when it rises above the center band. That central axis now supports price on pullbacks. When crossed, price tends to move all the way to the top band before any major reversal takes place. This pattern supports long swing entry when confirmed by other landscape features. The center band becomes resistance when price breaks below it. Odds favor price falling all the way to the bottom band when the central pivot breaks. This pattern supports short swing entry when confirmed by other landscape features.
1. Location and direction determine trading phase:
• Upper vs. lower action: Location of price bars determines the strength of the current phase. Price within the upper band signifies power while price within the lower band signals weakness.
• Price direction: Direction of price within the band identifies convergence-divergence with the current trend. Divergence prints when price rises within the lower band or falls within the upper band. Convergence prints when price rises within the upper band or falls within the lower band.
• Trend testing: The lower, center, and upper bands represent S/R for the trend. Reversal off any band increases odds that price will expand in the reversed direction and return to the last band crossed or touched.
2. Penetration through the center band increases directional momentum:
• Crossing from below center to above: Uptrend increase in strength. Observe directional movement of the upper band as price approaches.
• Crossing from above center to below: Downtrend increase in weakness. Observe directional movement of the lower band as price approaches.
3. Bands open in response to awakening trend:
• Climbing the ladder: If the angle of the upper band rises in response to approaching price, expect a series of upward price bars, each riding higher along the top band. This is an uptrend in progress.
• The slippery slope: If the angle of the lower band falls in response to approaching price, expect a series of downward price bars, each pushing lower along the bottom band. This is a downtrend in progress.
4. Bands flatten in response to awakening trend:
• Head in ceiling: If the angle of the upper band flattens in response to approaching price, expect price bars to pierce the band and reverse. This will likely end an upward swing and start a downward one. But watch if price pulls back slowly while the band then opens. This will signal an impending breakout.
• Foot in floor: If the angle of the lower band flattens in response to approaching price, expect price bars to pierce the band and reverse. This will likely end a downward swing and start an upward one. But watch if price pulls back slowly while the band then opens. This will signal an impending breakdown.
Bollinger Bands define natural extremes in trend development. As bands are hit, price often bounces backward until sufficient strength can push the band out of the way. Congestion will likely develop just below the top band or above the bottom band if the overall pattern supports increasing momentum. This will continue until the band turns and opens away from price, indicating that resistance has been overcome. Price may then eject into a sustainable trend and cling to the band’s edge. But keep in mind that ultimate movement will depend on all S/R boundaries and not just those associated with BBs.
Chart Polarity: The market simplifies this process through its native polarity. Price action shifts movement between two polar states or flattens it toward a neutral middle. This underlying axis characterizes almost all market phases, conditions, and indicators. For example, prices can only rise or fall with directionless periods in between. This signals the existence of bull, bear, or sideways markets.
Effective swing trading begins with identification of the current market phase. But strategies require more detailed information before trade execution. Start with the following questions: How quickly are conditions changing? Do they represent broad or narrow events? How will volatility affect the trading environment? The answers may mark the difference between a simple price correction and a market crash.
The most popular view establishes the 200-day moving average as the interface between bull and bear markets within individual equities.
Fibonacci retracement provides a more powerful tool for this purpose than standard moving averages. First establish the major uptrend or downtrend that guides the trade setup. Then draw a Fib grid over the extremes. During relative uptrends, avoid short sales when price remains at least 38% above the low. Through relative downtrends, avoid long entry when price remains at least 38% below the relative high. Alternatively, look at a violation of any 62% retracement as a shift through the bull-bear axis.
This simple concept may confuse at first glance. Trends and bull-bear sentiment actually represent separate forces. An uptrend can exist within a bear environment and vice versa. In fact, early phases of new trends often travel in a hostile atmosphere and without recognition by the crowd. Trend relativity also allows strong contrary movement in smaller time frames than the major bull-bear interface. Use this polarity to prepare pullback entry strategies. Identify the current sentiment and active trend within the market of interest. Watch for countertrend pullbacks when both forces line up. Follow price until it reaches a strong S/R level and then execute a position as it realigns with the primary force. The active trend should reassert itself quickly and carry price back in the other direction.
Ranges also carry a high probability for trend relativity errors. Participants trap themselves into narrow price movement while fixated on a broader trending market. Although the range limits losses, tied-up capital misses other opportunities.
Bulls live above the 200-day MA while bears live below. When trading within this time frame, align general strategies to conditions that favor the right side of the market. For example, stay long when price moves above the average and sell short when it goes below. Shorter-term traders must understand how large-scale bull or bear pressure can affect the performance of their individual trading vehicles. But they must align positions with smaller-scale buying and selling pressure to book profits.
Focus trading strategies on the trend-range axis but build timing on the swing-momentum cycle that underlies it. Positive feedback (directional movement) tends to surge in waves. These momentum thrusts carry all the rewards that swing traders seek. Negative feedback (nondirectional movement) sets the stage by providing the conditions needed to generate profitable entry points. Coordinate these two impulses to execute with perfect timing. Enter positions when the range nears primary S/R and then watch for momentum in the next lower time frame to carry the trade to a profit. As the position starts to run, align an exit to momentum in the same time frame as the entry to maximize the gain.
Identify trend-range through pattern recognition and indicator support. Oscillators such as Stochastics swing back and forth quickly through small shifts in range direction. Watch the indicator jump to one extreme and stay there when the trend takes over.
Use repeating chart patterns to uncover important swing points. Classic triangle, flag, and pennant formations locate trade setups with clearly defined entry and risk levels. Constricting price bars, lowering volatility, and range placement signal the end of one swing and beginning of a new impulse.
Bars tend to expand rapidly into a climax through rallies and selloffs. Then congestion sets in and volatility drops as bar range contracts along with price rate of change. This negative feedback characterizes progress until tight congestion signals an impending price movement that again releases into expanding bars. Pattern readers have a trading advantage here because these entry points capture the eye’s attention. Conversely, many math indicators hit neutral zones in this environment and show nothing of interest.
Swing traders must pay special attention to these overlooked neutral conditions. Quiet balance points trigger the most powerful and profitable opportunities throughout the markets. Empty zones have little sponsorship or interest. They draw their initial power in a state of low volatility and resolve it through directional movement and high volatility. They signal high-reward, low-risk entry levels that allow swing traders to step in front of the crowd. Because narrow range bars char acterize this opportunity, adverse movement after entry permits a fast stop loss exit with little slippage.
Odds increase greatly that the next few bars will contract when expansion bars thrust into known S/R. For this reason, the appearance of wide range bars often signals the need for caution. Look at the chart landscape again, identify all obstacles, and reexamine the intended holding period. The odds favor a pullback that will draw down profit substantially before ejecting into another move.
For most trades, plan to exit when price expands into S/R. This strategy tracks the old wisdom that advises us to ‘‘enter in mild times but exit in wild times.” Also consider closing the position when the market prints a wide range bar that departs substantially from the routine price action but does not occur at a breakout point. These often mark short covering moves, stop runs within smaller time frames, and countertrend climaxes.
The swing trader seeks profit from single, direct price thrusts except when highly favorable conditions demand greater flexibility. When momentum cycles align through several time frames, and positions already show a profit, try to capture a series of expansion bars. But recall that markets trend only fifteen to twenty percent of the time. Odds favor accepting the gift of a few bars and moving on to the next trade. Only seasoned trading skill can consistently select the right path to take with any particular setup. Learn to watch opportunity in three dimensions and take a giant step toward this wisdom.
Most technical indicators rely upon simple price/volume inputs. When these data points shift back and forth, they also generate chart polarity in derivative math calculations. This interrelationship explains why the swing trader should not seek the perfect indicator. The restless crowd drives price change, but mathematics only interprets the residue of their participation. The eyes see emerging trends long before the numbers signal their presence. For this reason, always use technical indicators to support the pattern, not the other way around.
All markets cycle endlessly between contraction and expansion. But congestive phases use up many more price bars than trending moves. This suggests why making money in the markets can be so difficult. A trend may already be over by the time most participants see a sharp rally or selloff. At the least, risk escalates dramatically as advancing price can reverse or enter new congestion at any time. The swing trader tries to enter a low-risk position just before price bar expansion, whenever possible, and let the breakout crowd to push it into a quick profit. Looking for contraction boxes and expansion boxes.
Markets can tap fresh crowds as prices move. New participants may quickly replace depleted supplies. This self-feeding trend mechanism allows extreme buying and selling conditions to continue long after measurements suggest that reversals should take place. Oscillators reflect this when they move to one extreme and just stay there. For this reason, don’t rely on these indicators in trending markets. They work best within constricted ranges where natural cycles allow regularshifts in supply and demand.
Swing traders must decide which forces will prevail as divergent conditions resolve. For example, when falling price bars move against a rising MA, one will eventually rotate to track the other. Common technical wisdom dictates that indi cators define an underlying trend more accurately than price over short periods of time. But this logic often fails and wayward indicators obediently turn to confirm the price action.
Apply a logical strategy to evaluate divergence and avoid very bad executions. Start with a recognition that every market will exhibit numerous C-D relationships. Limit detailed analysis to those elements that will support or interfere with the planned setup within the chosen holding period. Locate the major C-D themes and filter out the smaller ones. Some divergences tend to resolve more quickly than others. Accumulation can lag price for a long time before stopping a rally. But a declining moving average could have a dramatic effect on price as a short-term rally strikes it.
Apply cross-verification techniques to C-D trade analysis. Look for many discontinuous forms of convergence that support the promising pattern. Compare these with the elements that diverge to reach a logical conclusion about the next price direction. When convergence aligns repeatedly through a single price point, odds increase dramatically that an important breakout or reversal will occur right there. Couple this knowledge with well-marked S/R information and execute with confidence. S/R exerts a greater influence on price development than C-D. When a market builds a bullish pattern in the face of declining indicators, subsequent price action will more likely confirm the pattern than the divergent mathematics.
Success depends on overall market strength or weakness and how well positions capitalize on the changing environment. Individual entries can act against sentiment and yield good profits, but over time, the odds for success decrease when positions do not track movement in the larger indices and market cycles. Swing trading produces better results when riding the wave and not drowning in it.
Strategies that work well in hot markets destroy trading accounts during cool ones. Learn to read the broader market and adapt quickly to changing conditions. Build personal cycle measurements that bypass the financial press and stock board chatter. Use common sense to anticipate and test new profit strategies that the crowd may never see.
Swing traders must sell short as easily as they go long. This challenges the investor bias that most neophytes carry into modern markets. Many participants still don’t understand many aspects of this classic trading practice. The financial establishment discouraged retail customers from learning about short sales for many years. The uptick rule made entry difficult, while Wall Street told practitioners that they were hurting the American economy so that they could keep this profitable strategy for themselves. Times have changed. Direct access execution systems now allow short sale entry as quickly as long positions. Learn to use them without delay.
Pattern Cycles require a broad range of execution strategies in both directions. Be prepared to adapt quickly to changes in market sentiment by learning simple ways to recognize new broad-scale conditions. Market players who hit many singles will last longer than those who knock a few home runs but strike out the rest of the time. Be consistent and make a good living through both up and down trends.
Start with cross-market analysis and decide whether local or world influences will more likely move the price action. Stay aware of news or fundamental conditions that will impact the markets, but stay focused on the patterns and numbers. Except for shock events, markets will follow the technicals because insiders already trade most hidden news in advance of the public.
The interplay among debt, currency, and commodities can dramatically affect the U.S. equity markets. These broad forces trigger arbitrage between index futures and debt that move stock prices and rob profits. Fortunately, most significant shifts between these world markets occur slowly. Swing traders can adequately prepare for their substantial impact through a few well-chosen news articles or weekly index chart analysis.
Stay informed. Today’s excitement won’t move tomorrow’s markets. Learn to recognize the big picture and anticipate leadership through background study of economics, the media and world politics. Once grounded in the basics, just follow the financial news and the most important message of the day will become obvious. Modern markets have a self-fulfilling mechanism that pushes the most emotional issues right to the top of the trading heap. Study these central themes first and decide how serious or long lasting their impact may be.
Identify the leaders and laggards of the U.S. indices. Look at the Pattern Cycles for each index to find the current trading phases. Follow those indices and measurements that impact daily decision-making.
Capitalize on directional bias by watching for follow-through days. After wide range index bars, markets tend to surge in that same direction the next morning. This may occur as a large gap move or a just a slow grind. In either case, overnight positions use this tendency to increase profits. One popular strategy takes a closing position in a trending stock that prints a wide range bar and ends the day near its high or low. The swing trader then grabs a quick exit in the pre-morning action or early in the first hour before price discovery steals the profit.
Positions held after this first morning surge face increased risk. An opening gap often marks a short-term trend climax. Since markets require very strong trends to print two wide directional bars in a row, indices often reverse sharply right after wide range movement. Swing traders recognize this tendency and watch the volatile morning action very closely. They search their watch lists in advance for new setups that may benefit if a sudden reversal appears. Then they confidently time their execution to the broad indices when the market turns.
Work hard to find fresh opportunities in the equity markets. Start by throwing out most stocks as unsuitable for trading. These include REITs (Real Estate Investment Trusts), closed-end funds, ADRs (American Depository Receipts), and utilities. Then eliminate the bottom half to two-thirds of all stocks sorted by average daily volume. Seek liquid stocks that allow low slippage entry and exit.
A daily planning routine should identify promising Pattern Cycle setups, measure reward:risk and locate appropriate execution levels in advance. Build an automatic filtering process that evaluates every stock pick or scan objectively for these characteristics. The right workflow will uncover setups that support all three considerations. Realize that a single major flaw that doesn’t fit into the trading plan will negate an opportunity. For example, avoid a well-formed triangle breakout if potential reward doesn’t offer good profit or the pattern conflicts with other landscape features.
Watch out for the tendency to see something that isn’t there. Detailed review through scanning or chart study often uncovers the basic elements of a successful setup but offers no attractive entry. Unfortunately, this analysis process can induce a form of secondary reinforcement. It relaxes, puts the brain into game theory mode, and soothes the ego that sees all those past setups that could have been entered with perfect hindsight. This unconscious enjoyment encourages the mind to fill in the missing pieces on questionable new patterns. Always exercise rigid self-discipline when asking the eyes to look for opportunity.
The most urgent preparatory task throws out almost everything that looked great the first time around. Know when a setup has no potential and be willing to move on to the next opportunity.
Nightly preparation must uncover stocks that show so much promise that the swing trader just can’t wait for the next session. But before the new day finally begins, take a second look at every setup that rang the dinner bell just the night before. Good prospects should not lose their luster in the morning glare. Remember this golden rule for finding consistent winners: If you have to look, it isn’t there. Forget your college degree and trust your instincts.
Avoid trading the most liquid short-term stocks. Seasoned professionals actively compete against each other in Dell Computer (DELL), Intel Corp (INTC), Cisco Systems (CSCO), and Microsoft Corp. (MSFT). These stocks will crush most participants who lack extensive skill or experience. Note that the current trading style may not support their volatile price action. These high-volume stocks often move in price channels rather than simple lines.
Opportunity relates directly to the amount of time set aside for market analysis. Pick only one or two issues and follow them exclusively if trading time is limited to a couple of hours per week.
The ability to watch the markets in real-time determines the appropriate trading strategy. Lengthen the holding period to multiple days when positions can’t be followed tick by tick. Use both physical stops and limit orders to control risk. Real-time systems work best for the intraday swing trader and scalper.
Stock boards offer great places to chat with friends but do terrible damage to a trading account. Almost everyone on the Net has a hidden agenda, and all information must be treated with suspicion. Successful swing trading requires little knowledge about a company’s underlying fundamentals. Chances are that participation on a board will only reinforce underlying bias. Be prepared to understand the truth regardless of whether it helps or hurts an active position. Technical traders don’t believe in companies. They believe in the numbers.
Only price, time, and risk should trigger trading actions. Know the charts inside and out without looking at them. Pinpoint the exact location of price within each chart’s Pattern Cycle. Search for that S/R level where the crowd will jump in or where a falling knife can be caught with safety. Finding winners requires a level of emotional detachment that most individuals find very uncomfortable. Discomfort and profit often stand side by side.
Carefully evaluate how trading account size will impact the watch list. In general, available capital will rule out positions over or under certain price levels. Small retail traders may avoid issues over $100, while many professionals won’t look at stocks valued under $30–40. Small accounts should avoid the tendency to trade very low-priced stocks in the false belief that this will overcome undercapitalization. High relative spreads on these issues negate their greater percentage price movement. Bigger fortunes grow in small accounts that control risk than in those that chase quick rewards.
Scan by exchange as well as individual stock characteristics. Nasdaq’s popularity for short-term execution makes it the preferred choice for intraday traders. But position traders often conclude that the NYSE provides better opportunities for gain with controlled risk. Most participants can build effective watch lists through this simple method: retain the upper half of the NYSE but only the top one-third of Nasdaq. Avoid thinner Nasdaq stocks unless executing trades through a direct-access terminal that routinely fills between the spread. Without an execution advantage, illiquid stocks steal profits and ruin risk management. For long-side opportunities, consider an additional filter to sort low-volume issues by relative strength. Save only the best output from this group and add them to the universe of liquid stocks.
Stock percentage growth potential peaks at the very beginning of a new uptrend. For this reason, being right at a bottom can produce the highest profit for any trade. But picking bottoms can be a very dangerous game. Swing traders must weigh all evidence at their disposal before taking the leap and exercise strict risk discipline to ensure a safe exit if proven wrong. Losses must be taken immediately upon violation of the prior low.
PATTERN CYCLES
12. BOTTOMS
Stock percentage growth potential peaks at the very beginning of a new uptrend. For this reason, being right at a bottom can produce the highest profit for any trade. But picking bottoms can be a very dangerous game. Swing traders must weigh all evidence at their disposal before taking the leap and exercise strict risk discipline to ensure a safe exit if proven wrong. Losses must be taken immediately upon violation of the prior low.
Manage risk defensively—bottoms occur in downtrends. The greedy eye wants to believe the immature formation, and fast execution fingers may bypass better judgment. Even spectacular reversals offer little profit if price can’t ascend back out of the hole it came from. Violation of the prior low presents the natural first choice for stop loss. Make certain the entry permits a safe exit for an acceptable loss at this location. Don’t stick around long if the uptrend begins to fail. Price will gather downside momentum quickly at broken lows as it searches for new support
Rounded bottoms also provide opportunity for patient traders. Enter a long position after momentum clearly shifts back toward the positive, but realize that it may take some time for a profit to grow. Better yet, use rounded bottoms to identify bear markets that wash out and gear up for a new bull leg. The formation supports a very stable base for price to move upward once the pattern completes.
Double bottoms : A very sharp and deep first bottom (Adam) initiates this pattern. The stock then bounces high into a center retracement before falling into a gentle, rolling second bottom (Eve). Price action finally constricts into a tight range and the stock breaks out strongly to the upside. Many times
Eve’s top prints a flat shelf that marks an excellent entry point. Shelf resistance typically develops right along the top of the center retracement pivot. The relationship between this center pivot and current price marks the important focal point as the swing trader closely watches the development of the suspected pattern.
The Big W reference pattern maps the entire bottom reversal process. This signpost identifies key pivots and flashes early warning signals. The pattern begins at a market’s last high just prior to the first bottom. The first bounce after this low marks the center peak of the W as it retraces between 38% and 62% of that last downward move. This rally fades and price descends back toward a test of the last low. The swing trader then waits patiently for the first bell to ring. A wide range reversal bar (preferably a doji or hammer) may appear close to the low price of the last bottom. Or volume may spike sharply but price holds firm. Better yet, a 2B reversal prints where price violates the last low by a few ticks but then bounces sharply back above support. Focus attention on the potential second leg of this Big W when any or all of these events occur.
Initiate entry near the bottom of this second leg when multiple cross-verification supports the trade and conditions permit tight stop loss. The middle of the W now becomes the central analysis point for further setups. Price must retrace 100% of the last minor decline to jump to this level. This small move finally breaks the descending bear cycle. Enter less aggressive positions when this emerging second bottom retraces through 62% of the fall into the second low. But sufficient profit must exist between that entry and the top of the W center pivot for the setup to make sense. Longer-term participants can hold positions as price tries to mount this barrier but most traders should exit immediately.
Expect another upward leg after support establishes along the center pivot. The break of the downtrend invites many new players, and price has a high probability of rising further. Look for the next thrust to retrace 100% of the original downward impulse that pushed price into the first bottom. This final move completes both the double bottom and the Big W. The pattern may provide further opportunity on a quick pullback, but extended congestion can form in this area before trend pushes much higher. So assume a defensive posture and wait for the market to signal the next direction.
13. BREAKOUTS
Stocks must overcome gravity to enter new uptrends. Value players build bases but can’t supply the critical force needed to fuel strong rallies. Fortunately, the momentum crowd arrives just in time to fill this chore. As a stock slowly rises above resistance, greed rings a loud bell and these growth players jump on board all at the same time.
The appearance of a sharp breakout gap has tremendous buying power. But the swing trader must remain cautious if the move lacks heavy volume. Bursts of enthusiastic buying must draw wide attention that ignites further price expansion. The gap may fill quickly and trap the emotional longs when significant volume fails to appear. Non-gapping, high-volume surges provide a comfortable breakout floor similar to gaps. But support can be less dependable and force a stock to swing into a new range rather than rise quickly.
Moderate strength breakouts often set up good pullback trades. The uptrend terrain faces considerable obstacles marked by clear air pockets and congestion from prior downtrends. These barriers should force frequent dips that mark good buying opportunities. The swing trader must identify these profitable resistance zones in advance and be ready to act. Look for price to shoot past the top Bollinger Band just as it strikes a strong ceiling. This should define the most likely turning point. Then follow the price correction back to natural support and look for low-risk entry.
Price surges register on trend-following indicators such as MACD and ADX as momentum builds. Volatility quickly absorbs each new thrust and vertical rallies erupt. Abandon dip setups once this starts and try to catch these runaway expansion moves by shifting down to the next-lower time frame and finding small support pockets. Volume peaks as a trend wave draws to a climax while price expands bar to bar and often culminates in a final exhaustion spike.
Markets need time to absorb instability generated by rapid price movement. They pause to catch their breath as both volume and price rate of change drop sharply. During these consolidation periods, new ranges undergo continuous testing for support and resistance. To the pattern reader, these appear as the familiar shapes of flags, pennants and triangles. Relatively simple mechanics underlie the formation of these continuation patterns. The orderly return to a market’s mean state sets the foundation for a new thrust in the same direction. Price pulls back with declining volume but does not violate any significant support. The primary trend reasserts itself as stability returns
Congestion tends to alternate between simple and complex patterns in a series of sharp trend waves. This odd phenomenon occurs in both range time and size. For example, the first pullback after a rally may only print 8–10 bars in a tight pattern while the subsequent congestion exhibits wide price swings through 20–25 bars. Always take a look back at the last range to estimate the expected price action for the new congestion. Trade more defensively if the prior pattern was both short and simple. Go on the offense after observing an extended battle in the last range.
Swing traders must pay close attention to proportionality when examining continuation patterns. This visual element will validate or nullify other predictive observations. Constricted ranges should be proportional in both time and size to the trends that precede them. When they take on dimensions larger than expected from visual examination, odds increase that the observed range actually relates to a broader trend than the rally just completed. This can trigger devastating trend relativity errors, in which traders base execution on patterns longer or shorter than the targeted holding period.
Evaluate all patterns within the context of this trend relativity. A constricted range exists only within the time frame under consideration. For example, a market may print a strong bull move on the weekly chart, a bear on the daily, and a tight continuation pattern on the 5-minute bars, all at the same time. A range drawn through one time frame does not necessarily signal swing conditions in the other periods that particular market trades through.
14. RALLIES
Elliott Wave Theory (EWT) uncovers these predictive patterns through their repeating count of three primary waves and two countertrend ones. Wave impulses correspond with the crowd’s emotional participation. A surging first wave represents the fresh enthusiasm of an initial breakout. The new crowd then hesitates and prices drop into a countertrend second wave. This coils the action for the rising greed of the runaway third wave. Then, after another pullback slowly awakens fear, the manic crowd exhausts itself in a final fifth-wave blowoff.
Primary wave setups require very little knowledge of the underlying theory. Just look for the five wave trend structure in all time frames. While these price thrusts may seem hard to locate, the trained eye can uncover wave patterns in many strong uptrends. Trading strategy follows other types of swing tactics. Locate smaller waves embedded within larger ones and execute positions at convergent points where two or more time frames intersect. These cross-verification zones capture major trend, reversal, and breakout points. For example, the third wave of a primary trend often exhibits dynamic vertical motion. This single thrust can hide a complete five-wave rally within the next-smaller time frame. Locate this hidden pattern and execute a long position at the ‘‘third of a third,” one of the most powerful wave phenomena within an entire uptrend.
Dynamic third waves often trigger broad continuation gaps. These occur just as emotion replaces reason, and they frustrate good swing traders. Many exit positions on the bars just prior to the big gap because common sense dictates that the surging stock should retrace. Use timely wave analysis and a strong stomach to anticipate this big move before it occurs. It often prints right after several vertical bars close near the top of their ranges. Look for the last bar to reach right into broad resistance. Price should jump beyond that level on the gap. Also watch for RSI and other strength indicators to rise to the middle of their plots just as the big event erupts.
Fourth-wave corrections initiate the sentiment mechanics for the final fifth wave. The crowd experiences an emotional setback as this countertrend slowly generates fear through a sharp downturn or long sideways move. The same momentum signals that carry the crowd into positions now roll over and turn against it. But as the herd prepares to exit, the trend suddenly reawakens and price again surges into a new wave.
The crowd loses good judgment during this final, fifth wave. Both parabolic moves and aborted rallies occur here with great frequency. Survival through the last sharp countertrend (fourth wave) builds an unhealthy sense of invulnerability into the crowd mechanics. Movement becomes unpredictable and the uptrend ends suddenly just as the last greedy participant jumps in.
The bottom of the fourth wave should never touch the top of the second-wave. The second and fourth waves should alternate between simple and complex shapes. The fifth wave may exhibit a parabolic rally under the right circumstances but can also fail as soon as it breaks out of the fourth-wave range. Two of the three primary waves tend to print identical price change. The wave structure often exhibits very clean Fibonacci relationships. For example, two primary waves may print 38% each of the complete wave set.
Use volatile past action to identify effective trades when trend finally turns back through old price and begins a correction. Battles between bulls and bears leave a scarred landscape of unique charting features. For example, prior gaps can present excellent profit opportunities. Third-wave continuation gaps rarely fill on the first retracement, except through an opposing gap. Execute pullback entry in the direction of support as soon as price dips into a continuation gap, as long as the setup meets other reward:risk considerations. This pattern also generates good intraday setups because most major gaps occur overnight. But don’t jump in without first recognizing the important differences between continuation gaps and other, less dependable ones. Some will fill easily and trigger immediate price expansion in the opposite direction.
Past breaks in support identify low-risk short sales as corrections evolve. The more violent the break, the more likely it will resist penetration. Head and shoulders, rectangles, and double top formations leave their mark with strong resistance levels. These patterns often print multiple doji and hammer lows just prior to a final break as insiders clean out stops near the extremes of the pattern. Use their descending tails to pinpoint a reversal target for short sale entry.
Clear air marks price pockets with thin participation and ownership. These volatile zones often print a series of wide range bars as trends thrust from one stable level to another. This rapid movement tends to repeat each time that price action passes its boundaries. Potential reward spikes sharply through these unique levels for obvious reasons. But watch out: reversals tend to be sharp and vertical as well. Use tight stops at all times.
Parallel price channels offer the most common example of this multipath phenomenon. These complex patterns also offer very clean trade setups. Fade one trendline with a stop loss just beyond the violation point. Book the profit and reverse when price swings to the other channel extreme.
15. HIGHS
Swing traders discover great rewards in uncharted territory. Stocks at new highs generate unique momentum properties that ignite sharp price movement. But these dynamic breakouts can also demonstrate very unexpected behavior. Old S/R battlegrounds disappear at new highs, and few chart references remain to guide execution. Risk escalates with each promising setup in this volatile environment. The final breakout to new highs completes a stock’s digestion of overhead supply. But the struggle for greater price gains still continues. These strong markets often undergo additional testing and base-building before resuming their dynamic uptrends. Watch this building process through typical pattern development seen during these events.
New high stocks may return to test the top of prior resistance several times. This can force a series of stepping ranges before trend finally surges upward. Some issues go vertical immediately when they enter these breakouts. New high trade analysis faces the challenge of predicting which outcome is more likely. Let accumulation-distribution indicators and the developing pattern guide decision-making at these interfaces. Acc-dis consistently signals whether new highs will escalate immediately or just mark time. Price either leads or lags accumulation. When stocks reach new highs without sufficient ownership or buying pressure, they will usually pause to allow these broad forces to catch up. When accumulation builds more strongly than price, the initial thrust to new highs confirms the indicator signal. Odds then favor that the breakout will trigger a fresh round of buying interest and force price to take off immediately with no basing phase.
As stocks push into uncharted territory, examine the action through existing features of the pattern. The last congestion phase before the breakout often prints sharp initiation points for the new impulse. Locate this hidden root structure in double bottom lows embedded within the range under the breakout price. The distance between these lows and the top resistance boundary may yield accurate price targets for the subsequent rally. Barring larger forces, this new high should extend approximately 1.38 times the distance between that low and the resistance top before establishing a new range
Use Fibonacci extensions to establish initial price targets for new highs or lows. Trend thrusts often stretch 38% beyond the distance between the last high or low and the pullback before the breakout or breakdown. Find a double bottom or top within the congestion and stretch a Fib grid from that point to the last high or low. Then set the software tool to draw a line 38% beyond that level to reveal the target.
A strong bull impulse can go vertical for an extended period after it finally escapes initial breakout gravity. Price action may even print a dramatic third wave for the trend initiated at the final congestion low. This thrust can easily exceed initial price targets when it converges with large-scale wave motion. In other words, when forces on the weekly, daily, and intraday charts move into synergy, trend movement can greatly exceed expectations. This explains why so many professional analysts routinely underestimate stock rallies.
Measure ongoing new highs with a MACD Histogram indicator. Effective swing trading of post-gravity impulses relies on the interaction between current price and the momentum cycle.
Aggressive participants can enter long positions when price pulls back but the MACD slope begins to rise. Conservative traders can wait until the indicator crosses the zero signal line from below to above. Use the descending histogram slope to exit positions and flag overbought conditions that favor ranges or reversals. Ignore the MACD when well-marked charting landscape features signal an immediate opportunity. For example, if an established trendline can be drawn under critical lows, key entry timing to that line rather than waiting for the indicator slope to turn up or down.
Avoid short sales completely when price and momentum peak, unless advanced skills can safely manage the increased risk. Remember that trying to pick tops is a loser’s game. Delay short sales until momentum drops sharply but price sits high within a rangebound market. Pattern Cycle analysis will then locate favorable countertrends with much lower risk.
How long should a rally last when a stock breaks to new highs? Parabolic moves cannot sustain themselves over the long haul. Alternatively, stocks that struggle for each point of gain eventually give up and roll over. So logic dictates that the most durable path for uptrends lies somewhere in between these two extremes.
Overbought conditions trigger a decline in price momentum and illustrate one ever-present danger when trading new highs: stocks may stop rising at any moment and start extended sideways movement. Watch rallies closely to uncover early warning signs for this range development. The first break in a major trendline that follows a big move flags the end of a trend and beginning of sideways congestion. Exit momentum-based positions until conditions once again favor rapid price change. In this environment, consider countertrend swing trades if reward:risk opens up good opportunities. But stand aside as volatility slowly dissipates and crowd participation fades.
16. TOPS
Classic topping formations take forever to issue their reversal signals. Head and shoulders and double tops draw complex distribution patterns as the crowd slowly loses faith. While the swing trader waits, the herd takes notice of the action and all stand together to wait for the eventual breakdown. Since common knowledge offers few good opportunities, access to early warning of trend change provides a needed edge for profit.
Use the first rise/first failure (FR/FF) pattern to target new ranges and reversals before the competition. This simple formation works through all time frames and applies to both tops and bottoms. FR/FF signals the first 100% retracement of a dynamic trend within the time frame of nterest. Trends should find support during pullbacks no further than the 62% retracement, as measured from the starting point of the last wave that pushes price into an intermediate high or low. Healthy trends should base from this level and bounce toward a new breakout. The market reverses within this specific time frame if price breaks through this important support.
The 100% retracement violates the primary price direction and terminates the trend it corrects. Completion also provides significant S/R where swing traders can initiate defensive bounce trades. From this important pivot, continuation trends may reawaken in the next-larger time frame if they push through the 38% (62% retracement level of the downtrend) S/R and continue past the 62% (38% retracement level of the downtrend) S/R, toward a test of the last intermediate high.
Long side entry at the 100% retracement offers good reward:risk when it coincides with a 38% or 62% retracement in the next-higher time frame. However, the setup may develop more slowly than anticipated. In other words, a successful position must pass expected congestion through the 38– 62% zone before it can access a profitable retest of the old high and possibly move higher.
Allow for whipsaws at all major Fibonacci retracement levels before execution. Insiders know these hidden turning points and take out stops to generate volume. Also watch out for trend relativity errors. Bull and bear markets exist simultaneously through different time frames. Limit FR/FF trades to the time frame for which the retracement occurs unless cross-verification supports a broader opportunity.
Every popular topping formation draws its own unique pattern features. But all tell a common tale of crowd disillusionment. Whether it evolves through the loss of faith of the head and shoulders or the slow capitulation of the rising wedge, the final result remains the same. Price breaks sharply to lower levels while unhappy stockholders unload positions as quickly as they can.
Value and improving fundamentals attract knowledgeable holders early in a rally. But the motivation for new participants degenerates as an uptrend progresses. News of a budding stock rally creates excitement and attracts a greedier crowd. These momentum players slowly outnumber the value investors and price movement becomes more volatile. The issue continues upward as this frantic buying crowd feeds on itself well beyond most reasonable price targets.
Both fire and ice can kill uptrends. As long as the greater fool mechanism holds, each new long allows the previous one to turn a profit. But the right conditions eventually come along to force a climax to the upside action. A shock event can suddenly erupt to kill the buying enthusiasm and force a sharp reversal. Or the trend’s fuel may just run out as the last buyer takes a final position. In either case, the stock loses its ability to defy gravity and stops rising.
Many swing traders mistakenly assume bulls turn into bears immediately following a dramatic, high-volume reversal. They enter ill-advised short sales well before the pattern physics rob the crowd’s enthusiasm. These early sales provide fuel for the intense short covering rallies that most topping formations exhibit. Keep in mind that reversals only turn trends into sideways markets. Topping patterns must complete before they turn sideways markets into declines. Limit entry to classic fade strategies at the edges of S/R until the breakdown begins. Then initiate trend-following short sales to capitalize on crowd disillusionment and panic.
The descending triangle illustrates the slow evolution from bull market to bear decline better than any other topping pattern. Within this simple structure, examine how life drains slowly from a dynamic uptrend. Variations of this destructive formation precede more breakdowns than any other reversal. And they can be found doing their dirty deeds in all time frames and all markets.
17. REVERSALS
Why does the descending triangle work with such deadly accuracy? Most swing traders really don’t understand how or why patterns predict outcomes. Some even believe these important tools rely on mysticism or convenient curve fitting. The simple truth is more powerful: congestion patterns reflect the impact of crowd psychology on price change.
Shock and fear quickly follow the first reversal that marks the triangle’s major top. But many shareholders remain true believers and expect their profits will return after selling dissipates. They continue to hold their positions as hope slowly replaces better judgment. This initial selloff carries further than anticipated and their discomfort quickly increases. But just as pain begins to escalate, the correction suddenly ends and the stock firmly bounces.
For many longs, this late buying and short covering reinforces a dangerous bias that they were right all along. Renewed confidence even prompts some to add new positions. But smarter players have a change of heart and view this new rally as their first chance to get out whole. They quietly exit and the strong bounce loses momentum. The stock once again rolls over and draws the second lower top of the evolving pattern. Those still holding long positions then watch the low of the first reversal with much apprehension.
Prior countertrend lows draw scalpers and investors familiar with double bottom behavior. As price descends toward the emotional barrier of the last low, they step in and stop the decline. But the smart money stands aside and the subsequent bounce only draws in new investors with very bad timing. As the pattern draws its third peak, the last bullish energy dissipates from the criss-cross price swings. Price continues to hold up through this sideways action but relative strength indicators signal sharp negative divergence. Momentum indicators roll over and Bollinger Bands contract as price range narrows.
The scalpers depart and this final bounce quickly fades. Shorts now smell blood and enter larger positions. Fear increases and stops build just under the double low shelf. Price returns for one final test as negative sentiment expands sharply. Price and volatility then contract right at the breaking point. The bulls must hold this line, but the odds have shifted firmly against them. Recognizing the imminent breakdown, swing traders use all upticks to enter new short sales and counter any weak bull response. Finally, the last positive sentiment dies and horizontal support fails. As the sell stops trigger, price spirals downward in a substantial decline.
Stock charts print many unique topping formations. Many can be understood and traded with very little effort. But the emotional crowd also generates many undependable patterns as greed slowly evolves into mindless fear. Complex rising wedges will defy the technician’s best efforts at prediction, while the odd diamond formation will burn trading capital as it swings randomly back and forth.
Avoid these fruitless positions and seek profit only where the odds strongly favor the predicted outcome. First locate the single feature common to most topping reversals: price draws at least one lower high within the broad congestion before violating the major uptrend. This simple double top mechanism becomes a primary focus for short sale planning. Use this well-marked signpost to follow price outward to its natural breaking point and enter when support fails.
Flip over the Adam and Eve bottom pattern and find a highly predictive setup for topping reversals. This Adam and Eve top offers swing traders frequent high-profit short sales opportunities. Enter new shorts when price violates the reaction low, but use tight stops to avoid whipsaws and 2B reversals. These occur when sudden short covering rallies erupt right after the gunning of stops just below the failure.
Each uptrend generates positive sentiment that the topping formation must overcome. Adam and Eve tops represent an efficient bar structure to accomplish this task. The violent reversal of Adam first awakens fear. Then the slow dome of Eve absorbs the remaining bull impulse while dissipating the volatility needed to resume a rally. As the dome completes, price moves swiftly to lower levels without substantial resistance.
Observant swing traders recognize the mechanics of descending triangles and Adam and Eve formations in more complex reversals. The vast majority of tops display characteristics of these two familiar patterns. Crowd enthusiasm must be eliminated for a decline to proceed. Buying interest eventually recedes through the repeated failure of price to achieve new highs. Then the market can finally drop from its own weight.
Price draws a double top when it can’t pass the resistance of the last high. The more violent the reversal at the initial top, the more likely the first attempt to exceed it will fail. The longer it takes for this test to approach the first top, the more likely it will fail. When both conditions support a double top failure, swing traders can sell short into the second rise if:
• They are willing to exit immediately if price violates the old high.
• The execution target stands at or just below the old high.
The third rise into a top should rarely be sold short. Markets can easily head to new highs when they turn and rally after pulling back from a first failed test. This first attempt washes out shorts and those that missed selling on the initial top. The third rise allows accumulation to build and sets up a classic cup and handle breakout pattern. It also traps shorts from the failed test and uses their buying power to build a new uptrend.
18. DECLINES
The same crowd that lifts price provides the fuel for a subsequent decline. Longs build false confidence after rally momentum fades and a topping pattern forms. As smart money quietly exits, the uptrend hits a critical trigger point: the bulls suddenly realize that they are trapped. They start to dump the stock in an attempt to salvage profits. Price breaks support and selling spirals downward through wave after wave.
Common features appear in most price declines. Volume repeatedly surges through waves of selling pressure while false bottoms print and then quickly fail. Violent covering rallies erupt to shake out poorly timed short sales and offer hope to wounded longs. Price carries well past rational targets, but just as panic builds, the stock finds a sustainable bottom.
The swing trader capitalizes upon this repeating market behavior through the same wave mechanics that guide strong rallies. But fear replaces greed during sell- offs and invokes different setup considerations. When R. N. Elliott discussed primary trend waves in the 1930s, he noted the special characteristics of downtrends through the five-wave decline (5WD) pattern. This price correction structure remains as effective today as it was many decades ago. And swing traders can apply its power without understanding the broad Elliott Wave Theory, because it captures the fear of the emotional herd.
The 5WD consists of three primary trend impulses and two reactions, just like its uptrend cousin. Direct waves push lower in this complex pattern between countertrend bear rallies. The middle wave often prints a downtrend continuation gap as dynamic as the uptrend version. The last impulse can reflect parabolic movement driven by intense fear. After this drop, the uptrend may resume immediately. But more often price forms a double bottom or similar pattern that provides a good base for a breakout above the downtrend line.
The first impulse (TOP) corrects the uptrend that carries an issue to a new high. This often prints a first failure retracement. It also initiates the price decline that completes the stock’s technical breakdown through the third wave (1). Volume peaks sharply during this middle correction as shareholders recognize the ugly event. But the worst is usually reserved for last in major declines. As the third wave completes, a false bottom paints a comforting picture that slows the selling and brings in new value longs. The decline then suddenly resumes and accelerates into an emotional fifth wave (2) that violates popular targets and reasonable support zones. Note that the top of the fourth wave can reach up and touch the bottom of the second wave during the 5WD. This would violate common EWT rules if it occurred during a rally instead of a selloff.
TOP-1-2-DROP UP: Use this simple count to identify the five-wave decline and accurately predict trend reversals. The three primary waves mark the Top-1-2 in the 5WD pattern. Connect the third (1) and fifth (2) waves with a
trendline. The trendline can violate first (TOP) wave in any way. The first bounce after the (DROP) may come close to that trendline but will rarely violate it. Page 83, FIGURE 3.8
The fifth wave panic extinguishes the selling pressure and bounces the stock. This rapid upward motion squeezes shorts and ignites the first impulse of a possible new uptrend. The strong rally then quickly fails. As longs brace for more pain, the prior low unexpectedly holds. A new crowd notices the support and steps in. Price builds back to the 1-2 trendline as a double bottom forms. The balance of power then shifts and the stock breaks out through that line into a new uptrend.
Orient the decline against broader uptrend movement to predict price evolution. Start with Fibonacci retracement analysis and measure the selloff against the prior trends. One simple 5WD structure draws the first wave to 38%, the second to 50%, and the final impulse to 62% of a larger uptrend. This predicts that price will eventually return to test the high where the decline originally began. But if the pattern corrects 100% or more of a major rally, the subsequent bounce could be very weak and the stock may eventually go lower. Expect price to break through the down trendline in these conditions but quickly pause and drop back below new support. Trade defensively and capitalize on the price swings. Then shift tactics quickly when the bottom appears ready to break.
5WD short selling requires great precision. The 1-2 trendline consists of only two points unless the TOP aligns perfectly with the next two impulses. So this important signpost doesn’t really print until the second major selloff breaks to new lows. The first upward impulse after the climax marks a good short entry if price gets close enough to the trendline. But this setup carries a lower reward than the other downward moves and the position requires countertrend entry because price should eventually hold above the prior low.
The best short sales arise from natural breakdown points as impulses violate prior support. Avoid positions on the first impulse since this wave may complete with no technical breakdown. This first decline also faces a short squeeze danger and a large pool of potential longs. The second downward 5WD impulse (1) may begin close to the high of the TOP. This forms a classic double top pattern. Subsequent waves present less danger to short positions as the bear mentality undermines price recovery. Locate logical entry points where weak rallies bounce into major resistance.
Experience teaches that downtrends do not easily give way to new uptrends. While a break of the 1- 2 trendline marks the completion of the 5WD, subsequent price movement may not generate much momentum. Try to capture the expansion move across the trendline or the first pullback for a quick swing trade. Then exercise caution to see how the new uptrend develops. Remember the old adage: the bigger the move, the broader the base. Long declines need time to heal and the broken trendline may only yield to a sideways market. Price break momentum will be directly proportional to the distribution level during the previous decline. Recognize those times when price will likely rise at the same angle at which it originally fell, and watch out for those times when it won’t.
MARKET MECHANICS
Bull, bear, top, bottom, breakout, breakdown, high, low. That’s about it. Pattern Cycles continuously repeat the same stages through all charts and time frames. Successful swing trading requires little more than accurate recognition of a stock’s current phase and waiting patiently for low-risk execution. Learn the characteristics of each stage and start to think in 3D. Consistent profits come from chart elements that align through several time periods. But concurrent trends often stand in conflict and yield unpredictable results. For example, many trading losses will come from buying one trend while another signals an immediate sale.
Above all else, Pattern Cycles recognize the difference between bull and bear markets. Trend mechanics operate very differently through rallies and declines. Collar the position to the bull-bear axis and filter trades in tune with the predominant cycle. Countertrend entry works well but requires advanced execution skills. Don’t attempt it without extensive experience and careful planning. And avoid picking tops or bottoms in fast-moving conditions. The markets present much safer trades with equal rewards.
Try to execute positions just as countertrend movement ends and the primary trend reasserts itself. These pullbacks, dips, and bear rallies shift reward:risk strongly in the swing trader’s favor. Trend mechanics exhibit frequent and predictable countertrend movement. The challenge during these times lies in emotional self-control. Success requires buying when fear says sell and selling when greed says buy. Profit at that critical moment depends on adhering to the prime directive of technical analysis: play the numbers and forget the story.
All range patterns display a tendency toward continuation or reversal. This underlying bias generates their predictive power. Reversal patterns take longer to complete than continuation patterns. Swing traders exploit this tendency when they locate other congestion zones within the same trend and compare the bar count. Learn to recognize patterns well before they complete, and choose entry points where price momentum will likely erupt. Always keep in mind that reversal patterns tend to be more dependable than breakout patterns.
Trend has only two choices upon reaching a barrier: continue forward or reverse. Pattern Cycles focus trading efforts toward the more likely result and point to low-risk execution levels that capitalize upon the event. But effective analysis must also consider that the opposite outcome could develop. Many times this pattern failure will yield a more profitable trade than the one originally planned. So always see if an execution in the other direction might make sense. Charts consistently offer early prediction of these events through unexpected behavior near common breakout levels.
Price acts differently at tops and bottoms. Bottoms take longer to form, and declines from tops tend to be more vertical than rises off bottoms. This phenomenon illustrates a known gravity principle within the markets. Price bars appear to have a weight that influences their trend development. This odd tendency generates an inappropriate gravity bias that inhibits the ability to visualize dramatic rallies before they occur. Fortunately, self-therapy for this condition will cure it. Take a chart and throw it on the floor. From above, walk circles around it until you don’t know which way is up. The stroll confuses the mind and the bias will dissipate as hidden trade setups appear out of nowhere.
The big move hides just beyond the extremes of price congestion. Intermediate highs or lows within the boundaries of a range point to major breakouts when price violates them. They also locate major fade levels where the smart money recognizes that ranges persist longer than trends. First identify these important features through examination of the charting landscape. Then, rather than jump in with the crowd, wait for the herd’s reaction to these pivots before deciding which way to make the trade.
19. PRICE BREAKS
Trade new high breakouts differently than markets retracing old numbers. A special condition signals when stocks trend through new highs: no built-in supply of losers exists within that time frame. Price can easily go vertical when supply doesn’t overhang the stock from a larger trend. Pullback strategies often fail in this environment. During these momentum markets, swing traders may need to enter near highs rather than pullbacks and manage risk without close support under positions.
One typical signal for a new high momentum trade prints a tight flag at the top of expanding price right after a breakout. This common pattern appears on both 5-minute and weekly charts. As trends jump to new highs, bars congest while price searches for the next crowd to carry it higher. Congestion near the top of the range generates strong demand that attracts the needed greed. Price pierces the top of the flag and ejects into a vertical move.
Breakouts and breakdowns attract many participants but require precise timing to turn a profit. Insiders know that these hot spots attract dumb money. They initiate whipsaws after each volume surge to shake out weak hands. This ensures that the majority enters positions just as the market reverses. Swing traders rarely run with the emotional crowd and never with these frantic momentum plays.
Swing traders can join the momentum club, get filled way above their comfort level, and still walk away with a nice profit. But this practice will crush their hopes of success over the long term. Breakouts and breakdowns consistently lack easy escape routes. This fast-paced environment will chew up participants that don’t rely on flat stop losses. And glamorous momentum positions can trigger heavy losses but still maintain all the technicals of a good setup. That’s a formula for disaster.
Flat percentage or dollar stop losses will avoid serious problems. But swing strategy depends on price pivot behavior against known S/R barriers. New high trends often display no simple price floors. Whenever possible, enter breakout trades close to the point that proves the setup was wrong if price violates it. And consider that markets offer tremendous opportunities that don’t rely on strong momentum.
Breakouts and breakdowns tend to occur in waves. Quite often each surge prints at a similar angle, duration, and extent to the one that precedes it. Use this tendency to predict when the break will occur and how many points that price will move when it ejects. Between each sharp thrust, price will often stop and congest until volatility winds down and stability returns. Trade analysis yields the greatest benefit right at this point. Study the prior waves and locate any trendlines or channels. Count the number of bars within prior congestion zones. Locate the S/R level where a violation will likely trigger the next trend wave. Look at price ranges for the last few bars or candles. Do they narrow or expand? Plan the setup now and decide what to do if the stock gaps through S/R on the next bar.
Price breaks often stop dead after the first surge and pull back very close to the original S/R barrier. This second chance provides an excellent entry point. Although momentum traders watch their profits drop as the market retraces, the underlying technicals actually strengthen and encourage new entry. Sometimes price will jump back through the barrier that ignited the original breakout and drop into the old range. But if the break occurred with good participation, pushed well out of old congestion, and volume dries up during the pullback, get on board fast. The countertrend will rebound quickly and with little warning.
Action speeds up as price breaks free of congestion. Expanding bars or candles reflect surging momentum, regardless of time frame. Expansion equals profit. Swing traders who enter the first pullback try to pocket a big piece of the next price thrust. This strategy becomes extremely important in exit planning. Natural bias assumes that the position should be held until momentum and price movement slow. But this exposes a large profit percentage to natural retracement. Protect the position by using bar expansion patterns to signal the exit. Combine this method with Bollinger Band resistance and grab a high profit exit just as the market turns against the crowd.
20. Pattern Play—Quick Tips for Successful Swing Trading
• No two patterns behave alike. Triangles and pennants are ideal shapes that rarely occur with perfection in the real world.
• Three strikes and you’re out. Price should break out of a pattern no later than the third time a key price point is tested, to the upside or downside. Failure of price to reach the third test in either direction favors a breakout in the opposite direction.
• Use the rule of alternation to predict how a pattern will develop. Corrections should alternate between simple and complex shapes in a series of impulses.
• Every pattern has an underlying positive or negative appearance that represents the likely outcome. So if it looks bullish or bearish, it probably is.
• The sharp breakout above an ascending triangle often signals the climax of an entire series of rallies.
• Rising wedges can lead to very powerful upside breakouts, but they are too undependable to enter until the move is underway.
• Demand perfection on the inverse head and shoulders reversal. They attract attention only when every rule is fulfilled: the neckline must line up correctly, the two shoulder lows must be at the same price, and the breakout must pierce other known resistance (MAs, gaps, etc.) on high volume.
• Double triangles that form after strong rallies are very bullish for a new move of equal size to the one that occurred just before the first triangle.
• The contraction in price range and volatility that follows a new pattern seeks a natural balance point corresponding with the location of the new impulse. Use Bollinger Bands and rate of change indicators to identify this pivot in advance.
• Every pattern is a solvable puzzle defined by support, resistance, and volatility. Look for highs and lows to point to a natural exit spot in time. Volatility should decrease into this apex and expand out of it.
• Volume should dry up as each of the three rallies comprising the head and shoulders pattern uses up all the available bull power. The lower the volume on the right shoulder rally, the higher the odds that the neckline will eventually break.
• Excellent long trades on the head and shoulders can be initiated at the right shoulder neckline when accumulation diverges positively from the bearish pattern. Also watch closely when the neckline breaks but price immediately pops back above it and indicates that few stops were waiting.
• The deeper the downslope of the head and shoulders neckline, the greater the prospect for a bearish break. Stay away from ascending necklines completely. These patterns easily evolve into sideways motion.
• Calculate the Fibonacci relationship between the left shoulder peak and the head length of the head and shoulders pattern. If the left shoulder topped at a Fib retracement such as 62%, the right shoulder should go no higher and may be a good short sale entry point.
21. RECOGNIZING TRENDS
Remember to answer the three important trend-range questions in every setup analysis:
• What is the current trend or range intensity?
• What is the expected direction of the next price move?
• When will this move occur?
The transition from negative feedback into positive feedback represents a high profitinterface. Volatility, bar width, and volume all decline as a rangebound market nears its conclusion.Participation fades and many traders move on to other opportunities. But right at these quiet empty zones (EZs) the odds for price expansion sharply increase. The narrow bars encourage very low-risk entry where even a small move against the position signals a violation.
Examine the overall congestion pattern to identify which side of the trade to enter. The EZ rarely registers on technical indicators since most mathematics can’t digest the flatline conditions. Use short-term bar range analysis to locate this interface. The NR7 (the narrowest range bar of the last seven bars) offers one classic method to find the elusive EZ. The next bar after a NR7 will often trigger a major breakout. If it doesn’t, the appearance of a NR7-2 (the second NR7 day in a row) may ring an even louder bell. Odds then sharply increase for a major bar expansion event.
Price bar expansion-contraction presents a simple visual method for the swing trader to evaluate volatility. Trends generally reflect expanding bars, while range-bound periods exhibit contracting ones. The highest profitability will come when entering a position at the end of a low-volatility period (contracting bar) and exiting on a volatility peak (expanding bar) just as the trend pulls back.
Learn to recognize the early warning signs for a trend change. The evolution from trending into a rangebound or reversing market forces a shift in trading strategies to capitalize on the new conditions. First rise/first failure provides one effective visual tool to beat the competition at this task. Get defensive when price gives up 100% of the last move. Then apply classic swing tactics until the intermediate high or low gets taken out.
Use trend mirrors (TMs) to interpret these volatile chart zones. Look horizontally at past action to predict where price bars should bounce or fail. Current movement will often mimic the angle and extent of past patterns. TMs locate S/R hotspots just as clear air targets bar expansion. When price action swings repeatedly off either side of a mirror, odds increase that bars will act the same way during the next pass. These chart memory levels can act as classic S/R or mark a swing axis for price to shift back and forth. Each type requires an appropriate trading response.
The TM landscape defines profitable execution points throughout the range from old low to new high. But an infinite variety of external forces can overcome a stock’s natural tendency to reverse at exactly the same level it did in the past. Choppy action may repeat itself when price returns or one singular event may draw so much interest that other relative landscape features become undependable. Pass on low-reward conditions and seek TM levels that stand out dramatically as the current trend pushes towards them. Then seek cross-verification for the anticipated setup through moving averages, central tendency, and retracement tools.
The combination of gaps, spikes, and surging volatility can overwhelm analysis. But beneath this complex landscape lies order and structure. Lay a Fibonacci grid across prior trend movement and many terrain features will stand out right at major retracement levels. Add moving averages to enclose the price activity within known S/R behavior. Draw trendlines and parallel price channels to cross-verify expected turning points.
22. CLEAR AIR
Profits depend on the relationship between price and time. When price moves a greater distance over a lesser period of time, individual chart bars and candlesticks expand in length. This phenomenon signals those points of greatest market opportunity. Swing traders enter positions to capitalize on these expansion events. Charting landscapes print many pockets of thin ownership even though trading volume may be high. When price moves into one of these well-defined levels, bars often expand sharply and trigger a surge toward the next barrier.
Clear air (CA) identifies TM price levels where this volatility should spike. The more violent the prior events, the more likely it is that rapid price change will print on the next pass. This tendency allows swing traders to locate outstanding reward through fast visual scans of their favorite stock charts. Search for CA zones through repeated expansion bars that print at the same levels in past price action. Prediction is simple: the more often expansion bars show up at these levels, the more likely that it will happen again.
Apply Fibonacci grids after the completion of a clear air series to examine hidden reversal zones not apparent during the event.
The market never reveals its secrets the same way twice. While an arithmetic chart shows a weak trendline, the log version may support the trade with strong price channels. Volume study may provide the important key to one execution but be safely ignored on many others. Rising price may say rally when the Bollinger Bands say selloff. Swing traders must apply the right set of tools to build successful positions.
The charting landscape uncovers signposts through the convergence of two or more elements. This cross-verification (CV) process offers an objective method to determine the odds of success for any trade entry. CV power lies in this linear mechanism: the more intersecting points in a trade setup, the higher the trade probability.
Price gaps mark powerful single-point signposts. They expose hidden S/R barriers when properly placed within a trend. Gaps come in many varieties, and swing traders must drill themselves in their various incarnations to avoid bad decision-making when it matters most. For example, intraday traders use opening breakout gaps to pinpoint momentum entry and exhaustion gaps to sell short when price retraces to test them. Mixing the two leads to unfortunate results.
23. VOLUME AND THE PATTERN CYCLE
The intermediate daily time frame provides a common basis for volume moving average computation. The 50- or 60-day VMA (Volume moving average) contrasts prior crowd participation with the current action for all liquid stocks through all exchanges. Use this simple measurement as a central tendency tool that gauges the crowd’s emotional intensity in real-time. The crowd sends a significant signal when volume exceeds 150% of the daily average. If daily volume falls below 50% of the average, look for dull and directionless trading to characterize that market.
Volume peaks and valleys occur naturally within normal price evolution. They also tend to alternate in a cyclical pattern that parallels trend-range axis phases. Compare price placement within that axis against volume’s central tendency deviation to identify impending feedback shifts. For example, expect lower than normal participation within extended range formations. When volume suddenly peaks well above average within these constricted zones, it often signals an imminent breakout into a new trend.
Don’t be fooled by seasonal volume aberrations. January draws significant new cash into the markets as investors replenish mutual fund coffers. Summer trading limps through the lowest participation of the year. Insiders and institutions take off for the beaches during holiday markets throughout the year, leaving few movers and shakers on the scene. And options expiration triggers heavy position shifts the middle Friday of each month.
24. ACCUMULATION-DISTRIBUTION
Acc-dis evolves continuously and often travels a different path than price development. For this reason, avoid the tendency to expect volume spikes to translate immediately into sustainable momentum.
Shareholders buy and sell stocks for many different reasons. Short-term crowds tend to focus much more on current price than long-term investors. They can also flip stocks very quickly. Institutions lack this retail liquidity and must build or eliminate large positions over a longer time frame. As the largest fish in the pond, their slow movement inhibits the sentiment evolution that drives other participants. This induces backfilling and testing of new trend movement. For example, watch how price swings back and forth repeatedly through a key emotional barrier (such as the 200-day moving average) while undergoing a long-term recovery from a bear market.
Acc-dis may lead or lag price rate of change. Often one measure will pull sharply ahead and then wait patiently for the other to catch up before proceeding on another leg. Swing traders build predictive indicators to capture this mechanism and track divergence between these two primary forces. As the slower element, acc-dis tends to pull price toward it rather than the other way around. In these divergent conditions, look for reversals just after price strikes overbought or oversold levels.
When a stock hits a new high, only significant participation will carry it higher. When a stock hits a new low, a fearful supply of sellers will generate further decline. For this reason, swing traders measure divergence near these extremes to choose whether to fade price or go with a momentum break. Expect a reversal as price barriers exert their influence if acc-dis indicators suggest weak participation.
Avoid decision-making based on very short-term acc-dis readings. The true nature of accumulation or distribution often remains hidden from all but the insiders. Large players, such as institutions and mutual funds, don’t want to broadcast their intentions, for fear that the news will move the market before they complete their strategies. So they slowly unwind positions into strength or build them during weakness. This significant contrary activity clouds the interpretation and true meaning of short-term volume surges.
The best swing trading stocks have a float over 10-million shares and daily volume over 2-million. Volume-based indicators work extremely well with this broad participation. But be aware that Nasdaq double counts transactions, once on the buy and once on the sell.
25. TRENDS AND VOLUME
Expect volume to increase in the direction of the primary trend. Look for higher volume on up bars than down bars as prices rise during rallies. Reverse this during selloffs. In uptrends, more volume on sell-offs than rallies generates divergence that may foretell an impending change in trend. In downtrends, divergence again signals when volume shrinks on sell-offs and rises on rallies.
Volume can flash an early signal for an impending reversal when it deviates sharply from the VMA during an active trend. Declining directional volume suggests a loss of crowd interest. After a while the stock may fall of its own weight. Alternatively, when volume peaks too sharply or quickly, it can short circuit and blow off movement in the prevailing price direction. These high-volume climax events wash out both buyers and sellers as efficiently as lack of interest. They often mark major tops or bottoms.
Moderate volume supports underlying trends for long periods of time. It often reflects participation very close to the VMA with few spikes or valleys. The flow of enthusiasm or discouragement generates price change that feeds on itself and allows one group after another to toss coins into the wishing well. Look for this phasing action on log charts that print rhythmic 45° patterns with repeated pullbacks to short-term moving averages.
New trends awaken with price or volume leading the emerging directional force. Better trading opportunities with fewer whipsaws appear if volume builds first. When crowd enthusiasm leads price, acc-dis should exert a strong pull on its twin. Like a coiled spring, price eventually snaps forward to relieve the tension. For obvious reasons, swing traders want to enter positions just before this happens. But precise timing can frustrate the most promising volume-based strategies. Acc-dis price divergence can persist for long periods without quick release.
New breakouts depend on volume support. Subsequent trend survival requires that price and volume move into convergence very early after the move. As price thrusts into all-time highs or pretraveled TMs, current acc-dis must support the next move. Fresh price levels place hidden demands on volume. New high breakouts require ample participation as well as alignment between acc-dis and price. Breakouts into TM levels force volume to digest past supply and emotional scars. Divergence builds quickly and triggers sharp whipsaws when new participation at these levels can’t absorb the resistance.
Volume often spikes well above short-term VMAs during major breakouts. Greed and fear drive participation as the crowd recognizes the active trend. Volume can quickly exceed historical levels and surge for many bars at new highs or lows.
Swing traders watch closely for signs of a blow-off as trend advances. This important reversal reveals itself through volume that spikes well above recent action while related price bars expand and turn in failure. This climax event flags the end of the current trend and beginning for a new range period. Use candlestick patterns to quickly uncover these major reversals. Dark cloud cover, shooting star, and doji patterns all print frequently during blow-offs.
The trend’s last phase reflects the most active crowd participation in a bull-bear cycle. This frantic action corresponds with Elliott’s fifth-wave parabolic activity and sets the stage for the ensuing climax burnout. Once the event occurs, volume again surges when price approaches these levels from above or below. Extremes that print during blow-offs take great participation to violate. For this reason, fade early pullbacks to these climax bars through classic swing tactics. The reversal odds remain very strong as long as volume dries up on the move back toward the high or low.
When volume increases on short rallies and declines on dips, expect the bull’s successful outcome. Alternatively, a series of lower bars with increasing volume reveals fear and often signals an eventual breakdown. But regardless of direction, expect volume to decline overall as a new pattern draws to a conclusion.
Volume should taper off and dry up as negative feedback builds. A trendline drawn above the volume histogram will downslope to reflect this declining con dition. Near the end of range development, price and volume synchronize at the empty zone, that quiet terminus between negative and positive feedback. Participation reaches its nadir as the crowd turns away in oredom within this neutral interface. Watch closely from this center of apathy for evidence of the awakening trend. Use subsequent volume as one measure to locate an impending setup. When properly identified, participation on subsequent bars provides valuable feedback on the direction and strength for the impending move. For example, false breakout odds increase if price surges out of an apex without sufficient volume.
Avoid over-interpretation of intraday volume trends. Sixty percent or more of total daily participation occurs during the first and last hours.
26. Uncovering Market Bias through Volume
Does volume increase or decrease at relative highs or lows?
Range conditions generate small-scale trading patterns. Evaluate volume spikes as a stock swings back and forth to reveal small bursts of greed or fear within the crowd. One of these emotional forces will eventually ignite to ramp price toward the next level.
Is there a failed rally just outside congestion on higher volume than the rest of the range?
Insiders often gun the buy stops to take out that side of the market. This reveals a bias toward taking the market down.
Is there a failed breakdown just outside congestion on higher volume than the rest of the range?
Insiders often gun the sell stops to take out that side of the market. This reveals a bias toward taking the market up.
Do higher-volume days occur on narrow range or wide range bars and does bull or bears win these days?
Higher volume on wide bars suggests the market being pushed to generate transactions.
Higher volume on narrow bars suggests accumulation or distribution that depends on the outcome of the bar.
Does a silent alarm signal appear?
Certain volume events within ranges overcome all prior activity. Market character immediately changes when a massive volume day shows up.
Routine intraday volume consistently displays a high noise-to-signal ratio for all but the most liquid stocks. Intermittent peaks and valleys on 5-minute histograms contain few predictive properties and fail badly when block trades pass through the system. These institutional blocks distort the trading picture since large transactions often scroll well after the actual execution takes place. Noise decreases as liquidity increases.
27. SILENT ALARM
The SA alarm sounds when price action meets three conditions:
• Volume exceeds 3 times to 5 times the average 50–60 bar VMA.
• Price bar range measures below the average of the last 7 bars.
• The price bar sits within congestion not broken by the volume event.
This unusual zone reflects intense crossroads of buying and selling pressure. Emotional participation swells volume in a single bar, but a painful standoff develops between bulls and bears. Price sits still as friction reaches a boiling point. Swing traders who recognize the developing SA stand aside but then take positions in whatever direction that price finally ejects out of that bar’s range.
Alarms should not print a breakout through S/R. Price must remain trapped when the dust settles on that bar’s activity. Verify prior emotional trading at the same price level through TM investigation. Also make certain the high volume doesn’t reflect a prescheduled transaction such as a secondary offering.
Volume breathes differently than price. Narrow action may yield sharp emotional behavior or an unexpected lack of participation. Each outcome carries different consequences for swing traders. This crowd-measurement tool works well on daily charts but consistently undermines intraday signals. It offers both early warnings and dead ends, often at the same time. Volume reflects a crowd psychosis that often makes little sense in the short term but turns highly predictable at key intersections of trend and time.
Bear markets all display one common characteristic: they make it much harder to turn short-term profits than typical bull markets. Pattern Cycles suggest effective short sale tactics during individual stock bear markets. But volume drops sharply through most phases of a broad worldwide bear depression. This induces illiquidity and dangerous trading conditions. Spreads widen and slippage increases for both entries and exits. Opportunities vanish as good short sale inventories dry up at many broker-dealers. Reliable information disappears and good sources close up shop due to a lack of interest.
Historically this particular bull-bear cycle lasts about four years, with 25% (or one year) of that time spent in active bear conditions.
The typical bear market doesn’t end in the high-volume capitulation that marked volatile corrections in the 1990s. It slowly heals as value investors start to move back into positions. Many other participants will have little interest in the markets by that time.
A bear market corrects the excesses of a specific market uptrend. It retraces according to classic Fibonacci mathematics. When the prior rally displays a moderate advance, the bear market may not need a great pullback to correct the imbalance. But when market rallies extend to historical levels, conditions favor a very deep pullback that may take several years of basing before a new and sustainable rally can begin.
Opportunity depends on inefficiency. Price patterns expose inefficient markets that discharge their instability through rapid price change. Swing traders evolve fresh strategies to capture these events and build quick profits. But as high-odds tactics gain recognition, the crowd seizes them and inefficiency starts to close. Professionals then fade the setup and generate whipsaws that shake out many speculators. This intense competition for profit forces many swing traders to cut and run. They jump quickly to the next method that works, with the crowd always one step behind.
An effective market edge generates consistent trading profits. But most modern strategies must adapt continuously to the curse of common knowledge. Specialize on a single pattern for as long as it produces good results. But notice when unexpected outcomes start to undermine profitability. Stay focused and recognize immediately when the crowd discovers that pattern’s virtues.
Control your personal life first before taking a trade, or the market will do it for you. Keep in mind one disturbing fact: more swing traders will fail due to lack of discipline than lack of knowledge. Successful execution depends much more on the executioner than the strategy.
Profits require both effective risk management and emotional self-discipline. The greed-fear axis clouds the mind and opens the trading game to great danger. Use cold, objective rules to manage emotions and avoid the fatal traps that quickly end a career. Hope for the best but always prepare for the worst with each new position. Both extremes will happen regularly over time.
28. MOMENTUM TRADING
Pattern Cycles generate powerful strategies to capitalize on changing conditions and major turning points. But most participants fall into the momentum game and never learn other tactics. While the greedy eye sees many rising trends with few pullbacks, most still lose money chasing a hot market. Momentum traders at all levels lack sound risk management.
They realize too late that momentum demands precise timing and strict emotional control.
Momentum trading can be mastered. Three disciplines will break destructive habits and reprogram trading for success:
• Abandon the adrenaline rush: Forget the excitement. Profit depends upon detached and disciplined execution.
• Learn the numbers: The nature of price movement must be ingrained deeply enough to allow spontaneous decision-making during the trading day.
• Cross-verify: Objective measurements must filter unconscious bias.
Guide execution and position management through the chart in the next-lower dimension. When a strong trend explodes on the daily chart, use the 60-minute bar to pick out lower-risk entry and define natural exit points.
Successful momentum strategy requires solid tape reading skills. Watch the crowd’s response to support numbers very closely. If the swing trader can’t feel their urgency to get on board, perhaps it isn’t there. Use round numbers to gauge demand when the action pushes into uncharted territory. Multiples of 10 often present strong resistance in place of classic S/R levels.
Time-of-day tendencies cultivate profit and danger zones. As the market opens, overnight imbalance and fresh retail cash trigger volatility that resolves through price change. Insiders guide stop gunning exercises and fade trends through the lunch hour’s negative feedback. The final hour arrives, just in time to resolve many complex themes with sharp breakouts or breakdowns. And through it all, intraday buying and selling oscillates in an orderly 90-minute cycle.
Momentum strategies fail through most market conditions. Stocks trend only fifteen to twenty percent of the time. Constricted ranges bind price during the rest of its existence. Trading longevity requires diverse skills through both trending and congested markets.
29. COUNTERTREND TRADING
Constricted ranges dictate countertrend plays. Keep in mind that the first thrust into S/R usually offers the best fade position and that odds will deteriorate on repeated tests. And remember that swing entry is always very price sensitive.
Focus the intended execution near a single price level and stick to it. Never chase entry and always maintain a tight stop loss. Countertrend trades must execute with minimum slippage right at or close to known S/R. The swing trader should stand aside if conditions don’t allow for this narrow entry. These setups manage risk through small losses taken when positions violate specific S/R zones. A series of larger losses due to poor execution will eliminate a very good profit.
Target reward through examination of the local features. If possible, carry the position until price approaches the other extreme of the range. Broad congestion likely mirrors intermediate S/R that inhibits a quick price thrust across the pattern. Many swing traders find that single direct price moves without retracement provide the best conditions for a profitable exit. Consider getting out as price jumps into that first boundary. If this is the chosen style, the original reward:risk evaluation should confirm that this price target carries enough profit to make the trade worthwhile.
Major highs and lows attract interest more than any other charting landscape feature. This ensures a large supply of participants but also invites more whipsaws and unexpected outcomes. Apply this primary rule at tests of prior highs and lows: fade the first test after a significant pullback but trade in the direction of the extreme on subsequent tests. Price tends to break out of ranges on the third try (second test of a high or low).
Use small reversal patterns in the chart below the holding period to fade entry near S/R extremes. Adam and Eve patterns and double tops/bottoms present simple formations that apply this 3D technique. Short sales depend on price violating the bottom of the smaller top pattern, while long positions signal when price surges through the top of the smaller bottom pattern. This original method allows low-risk execution close to the larger high or low in anticipation of a favorable price move.
Victor Sperandeo’s 2B trade in Methods of a Wall Street Master and Raschke and Connor’s Turtle Soup in Street Smarts both trap the crowd as it leans the wrong way right after price violates a high or low but reverses immediately. As smart traders adopt these contrary tactics, many price extremes face increased danger of a swift reversal after the initial breakout or breakdown. The safest 2B fade strategy lags the crowd before position entry. Let the price action break through key levels but don’t execute in the opposite direction until it pops back across support or resistance.
Trade 2B setups defensively. The market may still want to break through the barrier. Ride the subsequent pullback to the first natural swing level and then exit. After a good reaction the trend can reassert itself quickly and take out the old extreme. This follows the wisdom to fade the first test of an old high or low but follow the trend on the second test. Apparent triple bottoms and tops often yield to significant breakouts or breakdowns.
Watch out when a new high or low retraces and forms congestion close to the price extreme. Simple continuation patterns can quickly ignite into new trend thrusts. Stay away from small pennants and short pullbacks when planning 2B entry. The best reversals for this pattern come when a sharp retracement occurs after the first high or low. The subsequent test should then print more price bars than the decline that precedes it. Also pay close attention to lower-pane indicators as the event approaches. The trade cross-verifies when oscillators diverge from price direction just as the old high or low breaks.
Pullback entry into a strongly trending market represents a major category of swing tactics. This classic setup buys the firs t sharp decline into support or sells the first bear rally into resistance. Exit depends on many factors, including personal trading style, holding period, and available capital. Subsequent swings also offer safe entry, but risk increases as trends evolve and reach overbought oversold conditions. In other words, each pullback after the first one has higher odds of being a reversal rather than a continuation pattern.
Central tendency presents high reward: high risk opportunities at the extremes of price action. These tactics work best in congested markets or in the extreme volatility near climax events. The strategy fades price when a long bar thrusts out of a Bollinger Band extreme more than 50% of its entire length. In rangebound markets, odds for success improve substantially when the top or bottom band aligns horizontally just before the violation and price thrusts into known resistance (other than the band itself).
Many swing traders freeze at breakout interfaces and fail to execute these profitable positions. Because most opportunity relies on crowd participation, they wait too long for confirmation rather than accepting the pattern signal that flags the impending move. The narrow-range setup depends on execution ahead of the crowd and lets their fuel carry the position into a fast profit. Reprogram trading rhythm and watch these unique formations to capture trends just before they appear.
Setups work best when executions align with market conditions. Shorting rallies in hot markets or chasing trends in dull ones both empty trading accounts.
Learn to read market cycles before the crowd. Cycle analysis uncovers trends ready to tighten into congestion and offers another tool to locate impending breakouts into new trends. Apply a 14-day slow Stochastic or RSI and measure the longer-term swing between buyers and sellers. Or plot a five-bar slow Stochastic under a 5-minute chart and look for the 90-minute S&P alternation cycle. At potential turning points, watch for reversals at trendlines, channels, and other natural break levels.
Study volatility through range bar expansion-contraction. Look for the range-bound NR7 (the narrowest range bar of the last seven bars) offers and trending wide bars that reflect shifting crowd conditions. Apply Bollinger Bands to bar range study. Watch for constricting bands around price as volatility decreases and signals an imminent swing back into bar expansion. Measure how quickly they turn out and twist as price momentum builds. Or plot classic lower-pane volatility indicators that track the central tendency aspects of price change.
Volatility routinely increases through the early phases of a trend, decreases in the middle, and peaks as it climaxes into a sideways range. Volatility decreases gradually through the congestion zone as volume dries up and price bar range narrows.
These peaks and valleys define points of swing trade opportunity. Frequent pullbacks after new breakouts offer low-risk countertrend entry. The dynamic third-wave trend environment favors momentum tactics as prices ramp bar after bar. Climax tops and bottoms invite central tendency trades at the extremes of overbought-oversold readings. Sideways congestion presents fade setups until the empty zone signals the start of a new trend.
Each position generates a probability for success or failure. Enter a trade only when highly favorable odds support the setup. Measure probability by the actual number of converging S/R points. This simple analysis dictates that the more CV (cross-verification), the higher the likelihood that the position will produce a profit. When four or more levels intersect (CV4), entry into that setup at the low-risk execution target (ET) has the highest odds for profit. Keep in mind that trade probability must also align with favorable reward:risk. A move in the profitable direction does little when the potential gain remains small.
Understand the nature of the ET and its relationship to cross-verification. This important swing trade concept represents the price, time, and risk that trade entry must be considered. The best ET naturally occurs right at the strongest S/R. But the most promising CV4 setup offers no trade if it lacks an appropriate ET. The market’s cruel nature generates many promising price expansion events with highly unfavorable entry points. Skilled participants must always manage execution as aggressively as opportunity to stay in the game.
Discontinuous information requires that different features exist independently of each other. Many types of S/R data actually derive from other calculations. For example, MACD Histograms arise from moving average data. Therefore, a setup does not cross-verify when MACD and MAs say the same thing. On the other hand, a hammer candle that strikes an old double top at the bottom of a horizontal Bollinger Band constitutes three unrelated elements that converge at a single point and suggest a major reversal. Take great care before accepting each CV point. Accidental combination of derivative measurements may carry substantial risk. The trade will inaccurately cross-verify and give false confidence to the position.
Cross-verification supports standard price convergence-divergence analysis. This method parallels the momentum cycle and confirms new trends. Multiple convergence improves the odds that the trend will continue. For example, when the Stochastics indicator moves sharply off a bottom, try to verify that observation with trendlines and pattern breakouts. Or when MA ribbons spread out, analyze the recent price bars to locate narrow range or wide range signals such as the NR7.
Fibonacci ratios offer excellent CV analysis. Stocks faithfully retrace certain percentages of prior movement before finally reversing or continuing the prevailing trend. These stair step levels identify significant setups when bottom pane indicators and landscape features converge to offer support. Apply a Fib grid to trend extremes and look for activity at the 38%, 50%, and 62% retracement levels. Price often bounces like a pool ball back and forth across this marvel of crowd mathematics.
General Electric sets up a dramatic CV4 signal on the daily chart just before ejecting into a rally. Consider the high odds against these unrelated elements converging at the same price level: 1. Price pulls back to test the downtrend line. 2. Price pulls back to the 62% retracement of the last rally. 3. Price pulls back to test the Big W center pivot. 4. Price pulls back to the center Bollinger Band.
Profits come from the other traders’ pockets. The markets have never been a team sport. Swing traders must be predators ready to pounce on ill-advised decisions, poor judgment, and bad timing. Success depends on the misfortune of others.
The trading core that acts on emotion rather than reason changes through every circumstance and defies accurate measurement. For obvious reasons, highly charged markets induce more herd instinct than quiet ones. Seek active conditions when looking for profit opportunities. Read the crowd’s excitement through total volume and the time and sales ticker.
Trade ahead of, behind, or contrary to the crowd. Narrow-range executions work best to step in front of the crowd before a breakout.
Never hesitate to go against crowd sentiment when the market telegraphs a reversal. But use careful timing and analysis before position entry. Crowds carry momentum that rarely allows instant directional change. Move down to the price chart below the time frame of interest and watch for small reversal patterns to print first. Then choose an ET that responds to that smaller pattern.
Use the crowd’s excitement to exit trades on wide price bars before deep countertrends reduce profits. Reversals occur at peaks of crowd agitation. Sharp pullbacks trap players when they get greedy or wait too long for confirmation of a rollover. Safe exit requires that swing traders step in front of the crowd and close a position into its waiting hands. Get out quickly on bar expansion into major barriers such as prior highs or lows and Bollinger Band extremes.
Monitor personal stock board behavior closely. These virtual boiler rooms do fill an important data function: they assist in measurement of the crowd’s emotional intensity for that stock. They also represent the pocket that the swing trader wants to pick.
Don’t be an investor and swing trader on the same position. Investment represents a belief in a stock’s underlying value or technical state. This bias will inhibit the ability to apply contrary strategies when the circumstances demand them. Investment relies upon wealth creation, while supply and demand drives trading. Don’t confuse the two.
Greed fuels stock rallies, while fear and pain guide selloffs. Each trend direction displays special chart characteristics that elicit different formation types. In other words, don’t try to just flip a chart upside down to predict price movement in very active markets. But smaller thrusts through range constriction show less variation from uptrend to downtrend. Here the crowd behaves in a more rational manner as it moves in and out of positions. The smaller doses of greed and fear look alike through these zones.
Consider the difference between uptrends and downtrends in the development of trading tactics. Stocks tend to fall farther and faster than they rise. Volume builds rallies, but markets will fall from their own weight. Greed burns out faster than fear, which must be healed over time. Fear induces panic selling more reliably than greed induces panic buying. Momentum traders duck for cover quickly at new highs, but value investors routinely exercise great patience at new lows.
Many active traders never sell short. The upward price bias of the secular bull market teaches painful lessons to short sellers who don’t apply defensive strategies. Long-term market success depends on the ability to adapt to diverse trading conditions. Many Pattern Cycle phases signal profitable short sales opportunities. As with long positions, these setups align according to the trend-range axis. Classic strategies sell tests of old highs within ranges and use bear rallies to execute lower-risk entries in downside momentum markets. Smart short sellers also focus the ET through several time frames and build profits through 3D charting techniques.
Avoid selling short near major market support levels.
Trends depend on their time frame. Swing traders can safely sell short into corrections that last only a few bars or days. But these brief entries require very careful planning. Review other time frames to avoid trend relativity errors, and examine the pattern closely to pick the optimum entry points. Once a selloff is set into motion, buyers pull away and make execution more difficult. Wait for a pullback entry or get more consistent results by taking a position in narrow-range bars just prior to the break. Classic contraction against a S/R barrier offers a great tool to locate short sales as well as long positions.
Countertrend short sales require advanced trading skills. First build a profitable history of selling into downtrends and rangebound markets. Intermediate declines within uptrends can produce outstanding results. But the underlying buying power restricts safe execution to a few well-marked setups.
Experience builds the required patience to wait for the perfect countertrend opportunity. Sell breakdowns from one S/R level to the next. This requires defensive execution, precise measurement, and immediate profit taking. Use a Fibonacci line tool after a sharp uptrend thrust to identify the 38%, 50%, and 62% retracements. Cross-verify with time of day, horizontal S/R, and Bollinger Band extremes. Move quickly and without hesitation. At times these pullbacks will turn into larger trend changes. For example, a sharp thrust through the 62% retracement signals a possible first failure opportunity. If still short, keep the active position into the 100% level.
Bulls and greed live above the 200-day MA, while bears and fear live below. This popular reference level defines whether broad-scale strategies are trend or countertrend in nature. Rallies tap a larger pool of potential buyers above this important average, while corrections tap a larger pool of sellers below it. One-to-three day swing traders can execute long and short strategies through these broad conditions without special considerations. But longer-term position traders must exercise defensive tactics and precise execution if they choose to enter against this major average. Try instead to apply classic trend-following methods in this holding period. Sell the pullback, follow it down, and place cover stops to lock in profits during bear markets. Reverse strategy and direction in bull phases.
Short-term participants have few commonly agreed-upon alternatives to the 200-day MA. Rely on Pattern Cycles rather than moving averages to identify the market stage for the time frame of interest. Then apply first rise/first failure and Fibonacci retracements to pinpoint multi-trend bull-bear cycles. Simple 13- and 20-day MAs offer good trend analysis but don’t mark long-term resistance when broken. Use the 50-day MA to signal intermediate resistance for declining stocks. This common setting triggers excellent short sales on the daily chart, and the shorter time period ensures many more tests than the broader 200-day MA.
Some stocks never participate in the market’s broad upward movement and can be sold short all the way to oblivion. These natural position trades provide excellent opportunities for swing traders as well. The most obvious strategy awaits bear rallies in sustained downtrends. Allow the stock to reach overbought levels on a 14-day RSI. As it tops out, watch for a reversal pattern to print on the chart below the time frame of interest. If the trade arises on the daily chart, look for a double top or similar breakdown on the 60-minute view and use that level as the trigger for execution.
Short selling requires peaceful coexistence with the short squeeze. This time-honored practice relies on herd behavior. Position the sale ahead of, behind, or against the crowd to avoid these painful bear rallies. Squeezes erupt after downward price expansion invites latecomers with very bad timing to sell short. These volatile events end as quickly as they begin. They can carry further than routine pullbacks after upside breakouts due to the market’s long-side bias. Keep in mind that short squeeze tops offer one of the best sale entry levels available. Shorts can fuel rallies up to a point in downtrends. Further price gains then require real demand.
Chasing downside momentum destroys trading accounts as efficiently as its long-side twin. Enter short sales on pullback rallies to reduce risk and increase potential reward. Sell into the end of a short squeeze just as buying power fades. The squeeze alone will not force a 100% retracement of the last downward thrust most times. That takes real buying demand. They usually fail below 62% of the prior decline unless real longs emerge. Observe major S/R as the squeeze progresses, and watch for reversals near the 50% and 62% retracement levels of vertical rallies. These can uncover excellent short sales, and upticks will always be easy to find
Channels and trendlines provide excellent short sale entry points as well. Draw a line across the top of declining lower highs to locate these important levels. Make sure to toggle between arithmetic and log scale—these lines appear on one or the other but not both at the same time. Watch as price moves up toward the line. Does the level converge with other key S/R or major moving averages? Does price strike the top Bollinger Band while it turns downward? If so, cross-verification signals a potential short sale ET.
Cut losses immediately and recognize errors quickly when short. Use supplementary technical tools to choose wise exits. Thirteen- and 20-bar daily Bollinger Bands point to clean cover zones when price strikes or violates the bottom band but the barrier remains horizontal. Hammer and doji reversal candlesticks predict that the next bars will go against the position. For intraday shorts, use a 5-8-13 (Fig. 2.11) and follow the same bar-expansion strategy that exits long-side trades. The 5-8-13 Bollinger Bands offer intraday traders a powerful analysis tool.
Pick a holding period early in the game and stick with it until a better one comes along. Align all trades to this single time frame until self-discipline allows strict management of multiple strategies. Simultaneous positions that rely on different time frames raise the odds of trend relativity errors and allow weak-minded participants to turn trades into investments. Successful swing trading requires time specialization. Each Pattern Cycle subset marks unique trends and conditions. Learn the important characteristics for a chosen holding period and use them to improve performance.
Two classic time frames attract most swing traders. The 1–3-day hold aligns positions to an underlying S&P futures buy-sell cycle. The 1–3-week hold parallels natural trend development on the daily chart. Both styles demand less time than intraday trading but offer dramatic profit opportunities with controlled risk. They also closely match common Pattern Cycle phases.
The 1–3-day swing measures an ideal holding period for many participants. The American markets tend to print 3-day mini-trends. Three strong bars often follow three weak ones. Three trending days precede 3 days of congestion. Apply the same strategies as the intraday trader but use longer chart views to locate ETs and exit points. Sixty-minute and daily charts work well for these overnight positions. Trade frequently but control risk with tight stop losses that focus on primary chart landscape features.
The 1–3-week position aligns to a monthly buy-sell cycle that grabs a large price swing without aggressive position management. It fits well into a lifestyle not obsessed with the financial markets. Use the daily and weekly charts to organize profit opportunities and focus on closing prices. Ignore intraday volatility to avoid trend relativity errors. Manage profit and loss through physical stops. Protect gains with trailing stops that give positions adequate wriggle room. Then set stop losses based on natural breakdown zones and walk away.
Position traders have more time to consider promising setups and ideal strategies. They also seek higher individual profits, execute less frequently, and incur lower transaction costs.
Consider time frame before every trade execution. Careful analysis must conclude that the setup works within the chosen holding period. This frustrating process will filter out many promising opportunities, but avoid chasing them. Successful tactics apply only to the swing trader’s natural time tendency and can fail miserably if they miss their target. Market cycles exhibit polarity between adjacent trends. When holding periods compress or expand, they shift out of phase and can trigger opposite outcomes.
Look for setups that also work well in the time frame above the targeted holding period. These will exhibit few reward barriers, good support, and timing that converges with the smaller view. Follow larger-scale charts closely after execution and exit quickly if conditions change. The 1–3-day swing traders examine reward on the daily chart but execute patterns on the 60-minute bars.
Trend relativity errors steal more profits than any other trading mistake. An excellent position for one holding period often fails in the next larger or smaller time frame. Natural price waves that generate through multiple trends must align with reward targets and the chosen time frame.
30. Use the chart above the setup’s time frame to establish reward:risk and the one below to fine-tune trade timing
Plan the trade; trade the plan. Swing traders must define a personal style, write it down, and update it frequently. Without one, they don’t know what it is and will fail the next time their wallet really depends on it. The personal style defines trading rules, holding periods, stock vehicles, execution criteria, and a series of filters that describe specific conditions under which to stand aside
Avoid the tendency to overtrade a small amount of capital in the hopes of building it up quickly. Concentrate on applying the limited cash into promising opportunities rather than flipping it repeatedly and incurring heavy transaction costs. Decide whether or not to use the account’s margin. Realize that margin increases both reward and risk. Trade with your head, not over it.
Define entry and exit rules. Start with reward:risk parameters and list conditions that must be met before taking a position. Many swing traders will not consider entry unless it shows a minimum 3:1 reward:risk. Short-term opportunities also depend upon the execution zone (EZ). This focal band surrounds the execution target and requires undivided attention as price bars move into it. Intermarket analysis and ticker interpretation then decide whether the ET warrants entry. Use rules to define exactly what must occur in the EZ before execution. Examine time of day, technical convergence, and underlying market sentiment to decide the minimum external support required for a position entry.
Focus on a specific price range for the current strategy. Then trade the right number of shares for each setup, regardless of account size. Opportunities that repeatedly cross-verify at a single point demand more shares than positions with lower odds for success. Limit total shares to manage risk and always reduce share size when trying out new tactics or time frames. Decide whether or not to scale in and out of positions. Consider doing it for one side of the trade but not the other.
31. Typical Personal Trading Plan
• Trade price range > $12
• Holding period: 1–2 hours
• Enter: break of 2-day high
• Enter: S/R break
• Enter: Adam and Eve double bottom
• Enter: 62% retracement
• Exit: Touch of top Bollinger Band
• Exit: Break of 13-Bar MA on 5-minute chart
• Exit: Return into first hour range
• Filter: No entry on negative TICK
• Filter: No entry from 11:45am EST to 12:45pm EST
The most important rule of risk management requires little interpretation: never enter a trade without knowing the exit. Each ET choice generates a risk profile based on the distance between the entry and major S/R violation level. This level (failure target) determines the point where price action proves that the trade was wrong and should be abandoned. This distance must be acceptable before each trade entry.
This exit must not produce a loss in excess of the swing trader’s predetermined risk tolerance. Target a permissible average loss as part of trading style and rule preparation. Smaller accounts must manage smaller losses than large accounts. Risk tolerance also aligns closely with reward measurement. The distance from the entry to the nearest S/R barrier in the direction of the trade (profit target) measures reward potential. Seek positions with reward targets that measure at least three times the calculated risk. Then estimate the actual dollar loss should the position fail and violate the risk level with the expected number of shares.
Many good positions should be avoided or exited quickly. Markets work well when setups yield profits, but trouble starts when they don’t. Each promising trade has high odds for failure that must be considered before entry. Many participants fall into a gambling mentality when things go wrong. They rely on luck to get them past the risk and into a profit. Never follow this dangerous path. Do not execute a position unless the effect of being wrong matches the individual risk tolerance.
Slippage increases transaction costs. Actual trade fills may fall far from expected execution prices. Swing traders can exercise more slippage control on entries than exits by using limit orders. Exits must often be taken quickly and through any door available. This leads to losses that consistently exceed risk measurements. Slippage and increased transaction costs must factor into reward:risk calculations. One easy method just pulls a half-point off the ratio. For example, the final number won’t exceed 2.5:1 if the original setup measures 3:1 reward:risk before real-world impact.
Seek low-risk entry whenever possible. Find setups with ET levels very close to S/R or look for deep pullbacks in well-established trends. Narrow-range bars offer safer entry than expansion moves. Spreads narrow and permit swift execution at specific prices in a quieter environment. Filter time as well as price. The first and last trading hours carry sharp volatility and higher risk. Avoid execution through discount brokers during this time or face high slippage and late fill reports that defeat loss management. And always consider the quiet lunch hour to enter positions for afternoon rallies.
32. win–loss calculations
%WIN = winners/total trades
AvgWIN = total profits/winning trades
AvgLOSS = total losses/losing trades
Different strategies emit different risk profiles. Scalpers tend to exhibit high %WIN and low AvgWIN, while position traders reflect low %WIN and high AvgWIN. Strong momentum markets incur high AvgLOSS. Momentum players must compensate for this increased risk through higher %WIN if possible, but that often fails. Swing markets increase %WIN but limit both AvgWIN and AvgLOSS. Swing traders can impact results through time frame and strategy choices more than any other market player. They may wind up at either extreme, depending on their risk approach.
The markets offer only three ways to improve profitability, regardless of trading style: raise the %WIN, raise the AvgWIN, or lower the AvgLOSS.
Loss-side management increases profits more quickly than chasing gains. Take what the market gives and move on to the next trade. Successful participants know when they’re wrong and execute a well-rehearsed exit plan. Learn this skill quickly because most traders lose more often than they win during a typical career. Enter every position with an exit door close to the entry to cut losses when wrong. Keep another just behind advancing price to protect gains when right. Expect some frustration along the way. Many stocks will whipsaw through S/R and shake out good positions just before taking off sharply in the right direction. Experience will reduce these unpleasant events but will never eliminate them completely.
Avoid physical stops as long as positions can be managed in real-time. This reduces stop gunning exposure and allows a progression of natural exit points. Swing tactics implement discretionary (voluntary) rather than system (automatic) trade execution. Terminate the trade when movement in the intended direction reaches a natural barrier that may impede further price change. Also get out when movement against the intended direction violates a natural barrier that may accelerate price change.
Focus on trailing S/R to locate appropriate stop loss for the intraday trade. Build a grid around advancing price with MA ribbons and Bollinger Bands. Apply the 5-8-13 settings and watch the averages closely. Exit on a break of the 8-bar that follows a very strong trend. Watch the 13-bar in moderate conditions and depart on a break of that level. Failure through this center point raises odds that price will expand sharply toward the other band extreme. The interplay among price, MA, and BB frequently points to a low-risk exit several bars before a serious reversal occurs. Consider an exit before the MA violates if price starts to roll sideways along the edge of the average.
External stop losses manage large cycle reversals. Individual stocks will turn and follow volatile intermarket conditions such as program selling or index breakouts. Mental stop preparation must identify external conditions that will terminate active equity positions. When unexplained reversals trigger sharp expansion on futures or index charts, close positions first and ask questions later. Don’t wait for a response on the individual stock chart. Use that short interval to escape before others take notice of the event.
A pullback will often follow the first violation of well-marked S/R in strong markets. One advanced strategy holds the position through the swing break and bids into the bouncing market to exit. While good discipline always grabs the first exit door, use this second chance when caught off guard.
Place an arbitrary stop to keep the trade within risk tolerance if momentum offers no obvious exit. Enter with the market in motion and place the exit order at any price that yields an acceptable loss. Better yet, bid into the market several times and place stops very close to the purchase prices. Then take a series of small losses in the effort to catch a major price thrust. Keep in mind that if a momentum market turns sharply, no stop loss will offer real protection.
Physical stops provide a convenient tool for parttimers that can’t actively manage their open positions. Enter the sell stop as soon as the trade produces a new fill report. Place the limit order on the other side of known S/R within the risk parameters for the position. Add reasonable wriggle room to avoid whipsaw exits. If the position survives the session, reexamine the stop that night and adjust as necessary. Continue to review nightly and push the exit door closer to current price as soon as it moves into a profit. Adjust it even closer as the price target approaches or time reaches the intended holding period. And consider a quick windfall exit after any sharp bar expansion in the right direction.
Aspirants must commit many hours to market study or avoid trading entirely. Develop a predatory instinct, avoid greed, and view this occupation as a lifelong quest. Work hard to complete every analysis in detail, and don’t cut corners. Part-timers can succeed but must specialize on a few strategies and skip broader study. Match execution with effort or pay the price.
Learn to coordinate trades so they align with these underlying tendencies. For example, don’t buy weakness in the last hour if price is below support. Time-of-day favors further declines for these issues near market close. The first and last hours attract most participants. But they carry higher risk than any other time period. Avoid this excitement until specific strategies can address the increased risk. Early opportunities disappear quickly and trap unskilled players. Highly profitable setups appear throughout the middle hours. Use this quieter time to build up trading skills and avoid the crowd.
Give up the excitement of chasing parabolic stocks and find quiet opportunity that books higher profits with less stress.
Focus on optimizing entry and exit. Work out a detailed strategy before each trade that accurately measures reward and risk. Write it down if possible and don’t stop until consistent performance proves mastery of the game. Play single direct price thrusts, stay defensive, and manage size to control risk. When buy signals don’t line up perfectly, skip the trade or enter a smaller position. And remember that precise entries on mediocre positions make more money over time than bad executions on good ones
Promising stock opportunities turn into disasters. Time works against the swing trader when conditions turn dangerous, and waiting to be right is the best way to be wrong. Those who hesitate in the face of doom get taken out of the action for a very long time. Fortunately, most patterns warn of impending shocks. Sharp reversals rarely occur in a single bar, and well-marked signposts scream the need for a fast exit. Always protect the trading account and listen to the chart’s message regardless of what it says.
Greed and fear bring out the extremes in human behavior. But swing traders can control the impact of emotion with solid rules and strict self-discipline. Rules must apply to all circumstances, regardless of how it feels or the short-term financial impact. Few can maintain this discipline perfectly, and most find themselves in dangerous situations. At those critical times, decide quickly how to steer the boat back into the harbor before it gets sunk.
Many participants seek excitement from the markets. Successful swing traders kill the thrill and practice inner detachment through each execution. They experience long periods of boredom but don’t use mediocre setups to escape the monotony.
Never marry a stock position. Don’t bother to find out too much about the trading vehicle beyond basic sector analysis. Swing traders understand that stocks represent numbers and nothing else.
Chart patterns and technical indicators are not created equally. A highly skilled technician can trade successfully using only a bar chart. But the most powerful set of market indicators has little value when viewed in the absence of price. Just try this simple exercise: buy a stock at oversold or sell it at overbought without looking at price. Not a good way to make money.
Chart pattern s reveal quirks of crowd greed-fear behavior. They represent universal fractals that repeat over and over again through all time frames. Best of all, they point to exact locations for low-risk trade opportunities. But neophytes should never rely on patterns alone for trade execution. Triangle and flag reading takes little effort, while technical indicator interpretation requires serious study. So many borderline participants walk the easier path and fail miserably when their profit depends on precise application of these powerful tools.
Chart patterns with true predictive power emit evidence that mathematics can detect and measure. When trading signals converge through both types of analysis, odds sharply increase that the opportunity will produce a valid result.
Understand two common indicator quirks and shorten the learning curve. First, well-known authors publish endless variations of the same few technical studies. Stick with the classics until they stop working or limit personal trading style. Second, all technical indicators suffer from the same limitation: they only work through certain market phases and not others. Identify primarily conditions in advance of setup analysis to avoid false readings.
Beware of the overbought-oversold trap. This convenient terminology implies a trading response when oscillators push into extreme territory. But this questionable strategy robs profits in trending markets. For example, common wisdom says to sell when Stochastics punches above 80 or to buy when it drops below 20. But this response fails during major breakouts and breakdowns. Always look to the pattern first before trying to interpret a technical indicator, and remember Martin Zweig’s classic advice that “the trend is your friend.”
Use both pattern analysis and technical indicators to predict future price movement. But the indicator must support the pattern rather than the other way around. Patterns handle reward:risk measurements as well as price targets and identification of the optimum execution target. Apply indicators to uncover hidden divergence and flag impending reversals. For example, don’t buy congestion in anticipation of a breakout when Stochastics rolls over sharply from an overbought state. Or avoid short sales in bear markets when RSI turns up from an oversold state.
Trading tools must address both numbers and emotions to locate promising setups. While state-of-the-art software builds very complex buy-sell signals, most indicators miss the emotional tension that ultimately drives price change. Turn to the visual examination of recurring price and volume patterns for this essential task. Effective pattern analysis uncovers crowd behavior as it finds signal within the random noise of stock charts. Classic formations contain response fractals that predict how volatility and price movement will evolve over time. A seasoned pattern reader can often ignore mathematics (and fundamentals) when underlying price development paints a sharp picture. But most swing traders still need to apply math-based indicators to verify important observations and filter bias.
Every good analysis should validate current conditions through both forward (strength) oscillators and backward (momentum) indicators. Popular oscillating tools, such as RSI and Stochastics, identify overbought-oversold markets. Moving averages and MACD look back and measure momentum change. Or swing traders can just draw simple trendlines and channels in all time frames and use those instead as primary momentum tools.
Apply analysis tools equally to all time frames. But adjust indicator settings to the special characteristics of each holding period. Many strategies work best when the math aligns to the common crowd view. This taps its herd behavior and allows the swing trader to anticipate its next move. For greater flexibility, toggle between popular and custom settings to review the differences in signal output.
Pack indicators into 5-minute and 60-minute charts to track the intraday markets. Fill both upper and lower plots with layered information so that a single glance effectively captures current conditions. Apply 5-8-13 Bollinger Bands to identify short-term trends and intraday S/R. Place a smoothed five-bar stochastics under candlesticks to measure oscillation between buying and selling behavior. Then plot a classic 12-26-9 MACD histogram beneath the 60-minute bars to visualize broad intraday swing cycles.
Apply classic 20-day Bollinger Bands to track crowd behavior for swing positions from 1 day to 3 weeks. Plot a 14 day, smoothed RSI beneath price to measure longer-term overbought-oversold conditions. If possible, observe daily volume with a color-coded histogram that marks up days in green and down days in red. Place a 60-day volume moving average right across the spikes to signal when individual sessions draw unexpected interest. And always toggle between daily and weekly views for all indicators to view broad cycles that may affect position management.
Build indicator knowledge through study of the core elements of price, time, and volume. The vast majority of popular indicators use only simple snapshots of price and/or volume over specified points in time.
Many oscillators measure the distance between a bar’s closing price and range high to predict underlying buying power. Price itself represents the ultimate leading indicator with these simple tools. But keep in mind that derivative calculations always emit slower information than the data itself. While this smoothing process benefits swing traders who tend to act too quickly, it can also generate late signals.
Time invokes an indicator’s power as it compares key values and marks developing trends. Period-based snapshots sum up this price-volume activity and quantify relative movement. Fresh calculations then examine each new piece of data so the swing trader can make informed predictions about future price direction. Indicator time frames destroy the best tool’s effectiveness when they don’t align properly with current cycles or holding period. Alternatively, resonant time readings with mediocre tools will generate startling accuracy in prediction.
Study of market volume has two primary functions. First, it attempts to measure actual levels of accumulation and distribution hidden under the massive flow of the ticker tape. Second, it gathers up the crowd’s divergent impulses and evokes graphic images of their herd behavior. Volume indicators comprise a significant subset of all technical analysis. But they offer far less useful information than most price-based tools.
The lack of a simple linear relationship between volume and price change frustrates attempts to make accurate predictions. Volume leads the crowd as often as it lags, and it always seems to make perfect sense in hindsight. Timing trades to volume signals alone yields very poor results. Always combine volume study with price action before making important decisions. Swing traders should apply a simple histogram and accumulation-distribution overview to most charts.
Most technical indicators tune to preadjusted settings by the author, charting software or website. Use these canned inputs to track crowd behavior, but set them aside when growing skills demand original strategies. Common parameters can misalign with particular tactics and trigger execution decisions that depend on false information.
Vary time frame to track cyclical price behavior and build a 3D trend model. Place one custom set above and below a central study that correlates with the chosen holding period. This may require plotting different indicator types for each length chart. For example, to track faster signals on intraday holds between 1 and 3 hours, try a 6-17-9 MACD histogram on a 60-minute chart, 5-3-3 Stochastics on the 5-minute, and watch the broad daily action with 8-day Bollinger Bands.
When a classic analysis method gains popularity with the masses, price adjusts to undermine its most common outcome. An indicator may stop working entirely when the trading majority bases decisions on that price examination. This popularity forces constant reevaluation of indicator effectiveness and choice of parameters. Common knowledge focuses upon specific time periods and smoothing averages. Swing traders adjust by phasing their parameters ahead of or behind those of the crowd. This capitalizes on the herd instinct and uses its behavior to build trading profits.
33. Core Elements of Popular Indicators
Indicator Element
ADX Bar Range
Chaikin oscillator Volume
Commodity channelindex Price deviation
Historical volatility Price deviation
MACD histogram Price moving average
McClellan oscillator Daily breadth
MoneyFlow Up closes vs. down closes
Rate of change Price
RSI Up closes vs. down closes
Stochastics Bar close vs. bar range
Trendlines reflect hidden market order as well as self-fulfilling prophecy. Because many market participants watch straight-line extensions of two prior highs or lows, odds increase that any extended line will support or resist price when struck. Trendlines grow stronger after each successful test. Some may persist for years, while others may break in minutes. An individual trendline will print on the arithmetic or log scale chart, but not both at the same time. Always toggle between chart types to uncover these important S/R barriers.
Trendlines have many applications beyond their well-known uses. The indicator plots average momentum for the trend that forms the line. The rate of price change up or down the line always remains constant. Therefore, these straight lines reflect momentum convergence-divergence when compared with other price inputs. For example, momentum increases when price expands away from a trendline and decreases when it rolls toward the line. Also monitor the distance between trendlines and major moving averages. This oscillation provides significant timing feedback when used in conjunction with Pattern Cycles.
Legitimate trendline breaks display common price mechanics. Bars expand sharply away from the violation point on greater-than-average volume. Pullbacks occur, but not until price prints a good distance away from the break point. Volume then declines on a slow reversal back toward the former barrier. When price breaks a trendline on low participation and doesn’t expand quickly, an immediate jump back across S/R often occurs. This behavior triggers an excellent pattern failure signal in the opposite direction. Watch for price to draw a miniature reversal pattern right across the trendline. Use these small double tops and bottoms to signal a low-risk fade entry.
The relationship between trendlines and the charting landscape shifts relative to the time frame of each element. The swing trader must properly tune time to explore different aspects of momentum. Make certain the time inputs match holding period for the intended execution. For example, the plot of a 6-month trendline has little meaning for intraday trading unless price touches it that day. But the return of a 5-minute candlestick to a 3-hour trendline may pinpoint a profitable entry zone.
The first break in a major trendline does not signify a reversal. It flags the end of a move and beginning of sideways congestion. Take the time to understand the difference between that phenomenon and an actual trend change. Congestion represents an important feature of the underlying trend. It often leads to a new price thrust in the same direction as the previous one. Sometimes congestion evolves into a legitimate reversal, but other conditions must support the change first.
Price action rings a profitable buy signal when it remounts a broken trendline. This occurs after a pullback that follows the breakdown. Momentum reverses in the direction of the trendline, and significant participation spikes price back through the line. Support from this new floor should be strong and eventually push the growing rally into another breakout move. Look for price waves to print a series of rising trendlines that arc upward above the original remount level.
Charting landscapes may print conflicting trendlines within the same time frame. This adds considerable noise to any trade analysis. Each intersecting force must resolve price direction through crowd participation. When two or more trendlines clash, consider a quick position exit until conditions resolve. Don’t confuse this event with trendlines that print within different time frames. These represent important profit opportunities. This setup predicts that price within the smaller wave will come under the influence of the larger trendline and reverse course.
34. Psychotic trendlines
Psychotic trendlines (PTs) encompass all straight-line phenomena not covered by classic charting landscape rules. They recognize that some market participants will act on the extension of any two price pivots. PTs don’t have the power of normal trendlines but can exert tremendous influence on price development. For example, watch their great impact when vanishing trendlines suddenly reappear after months or years. Evaluate PTs in relation to other chart elements and use them for simple cross-verification. Also determine whether they define classic S/R or swing axis events.
First locate a PT on a chart of interest. Then see whether price gaps through it repeatedly or whether bars swivel back and forth across its boundaries. This signals a pivot bias for that line. Next categorize whether the slope trend is up or down and whether it acts more as support or resistance. Then trade primarily in the direction of the slope if the PT shows classic S/R. For example, if the trend descends and displays price resistance, sell that market at the line.
Apply simple trading rules with pivot PTs regardless of trend slope. Expect that price will hold the first two times that it strikes the line but fail the third time. This tracks the same strategy that swing traders use for the second test of a horizontal high or low. If the PT also exhibits multiple gaps through past pivots, odds increase for a gap to ultimately break the line. But don’t take the trade unless cross-verification also pinpoints a breakout or reversal at this level.
Parallel price channels (PPCs) build across the highs and lows of relative price movement. They print two sets of trendlines at an equal distance to each other and can persist for long periods of time. PPCs have greater predictive value than simple trendlines and work with many different strategies. They form on either arithmetic or log scale charts, but not both at the same time. They owe their existence to Fibonacci proportion within trend development.
Frequently, small channels embed themselves into larger ones. At times, swing traders may find three or four sublevel PPCs on a single major trend. These multiple-timeframe PPCs have a great advantage over trendlines. Complex trading systems, such as Elder’s Triple Screen, can be applied with great ease when they appear.
Channels persist because the crowd sees and acts upon them. This unique formation demonstrates considerable potency, although modern PPCs print more violations than in the past. While other common patterns whipsaw participants into oblivion, channels print their classic mechanics more consistently. It may be that this stable Fibonacci structure cannot be easily altered by the insider manipulation that weakens other patterns.
PPCs offer more versatility than trendlines in finding low risk entry. The two primary lines display natural reward targets and focus attention on clear violation levels. Harmonic parallel lines often form between the two extremes. These intermediate S/R levels target short-term swings, especially when they intersect with moving averages. Violation of any harmonic line raises the odds that price will continue to the next parallel support level.
PPCs demonstrate Fibonacci behavior that allows visual traders to make accurate predictions without using a calculator. Many channel strategies closely follow trendline and S/R concepts. Choose setups based on the channel’s time frame persistence. The longer a pattern endures, the more likely that it will support the trade. Always search for other S/R to cross-verify PPC xtremes. When moving averages, Bollinger Bands, or Fibonacci retracements cross parallels, risk decreases and potential reward increases.
Channels may take months to form and last for years. Due to broad movement over long periods of time, locate monthly and weekly PPCs with log scale charts rather than arithmetic ones. Observe all the S/R information on these large and complex formations and then drill down to very short time periods to build detailed insight on embedded price movement.
When a major gap opposes the current market momentum, it represents the only chart phenomenon that signals trend change without a common top or bottom pattern. A short or long price bar can stand at the far end of a gap move. Long bars tend to predict a quick follow-through in the direction of the gap. Short bars suggest sideways action or a pullback test into the violated space.
The gap’s location reveals both the character and mechanics for subsequent price action. Sharp gaps through clear S/R signify important breakouts and breakdowns. Pressure can build so strongly at these levels that the opening tick prints far from the last close. Emotional bursts can trigger multiple gaps as active trends build momentum. Gaps that print within congestion display far less persistence and may fill with little warning or volume. And high intensity gaps that occur late in strong rallies or selloffs often signal the end of a trend.
Certain S/R events only verify when strong volume accompanies them. For example, breakout gaps without adequate volume invite a strong reversal even if they print at a perfect location. This relationship between gaps and crowd participation relies upon complex interactions. For example, a high-volume gap may end price movement in that direction if it uses up the last available supply for that trend. But another gap with less volume may leave enough on the table to ensure new surges of momentum.
Breakaway and continuation gaps should print volume that sharply exceeds the 60-bar VMA. Both events provide excellent trades in the gap direction when the trend first pulls back to test them. They hold S/R the vast majority of the time and identify low-risk, high-reward entry. Markets retest most breakouts very quickly after they occur. If successful, price often moves sharply away from the pullback level. But many bars can pass before price retraces to a continuation gap. Crowd intensity tends to carry the trend well past the gap before it yields to any substantial test. Exhaustion gaps fill more quickly than breakaway or continuation gaps.
Exhaustion gaps print as trends and indicators reach extremes. This last burst may occur on very high volume, but a lack of participation does not negate the pattern. Exhaustion gaps fill easily and warn that the trend is over. Price fills the gap and often pulls back to the hole from the other side before a correction proceeds in the closing direction. Congestion patterns may form through wide gap ranges before yielding to substantial movement. Keep in mind that an exhaustion gap may turn out to represent a hidden continuation gap in the next-larger time frame. This odd phenomenon requires a sharp eye and often does not reveal itself until the larger trend ends. Use the dark cloud cover or bearish engulfing candlestick patterns to uncover these dual gap candidates.
Gap creation aligns with Elliott’s five-wave trend theory. The breakaway gap corresponds with the initiation of a dynamic first- or third-wave impulse. Runaway emotions emit the continuation gap at the center of the third wave. Then the trend sequence ends through the fifth-wave exhaustion gap. The continuation gap routinely marks a halfway point for the entire trend. Swing traders use this knowledge to target major reversals.
The first test of a continuation gap often occurs after the closure of an exhaustion gap. Markets retrace five-wave trends according to Fibonacci proportion. Pullbacks often fill the primary fifth wave completely through a first rise/first failure pattern. Without strong support, the countertrend thrust then continues until supply-demand equalizes and reawakens the underlying trend. The continuation gap marks the natural 50% retracement, providing the support needed to force a reversal.
Watch for false gap fills. Modern market action closes many continuation gaps for a bar or two before price thrusts sharply back in the direction of support. This likely reflects growing common knowledge of this fascinating S/R point. Don’t let this whipsaw phenomenon negate these profitable trade setups. Entry at the far side of the gap offers very low risk as long as volume remains flat. Less aggressive traders can wait for price to remount the hole and then execute as the gap reopens.
Continuation gap trades provide high probability entry, but keep in mind that the subsequent swing will likely fail before it again tests the exhaustion gap. Deep pullbacks face an extended period of price discovery as trend volatility dissipates. Longer-term positions can survive this process, but swing trades may not. Use trend mirrors to target an acceptable reward before choosing to execute a gap trade. Exit quickly on the first reversal thrust unless patience allows an extended position.
Always distinguish between gaps in the direction of the prevailing trend and those going against it. Countertrend gaps often flag major reversals without a long series of price bars. The most important shock events occur right near major highs or lows. A sudden break in the wrong direction after a strong rally generates fear among the crowd and may ignite herd behavior that leads to considerably lower prices.
Opening gaps fascinate participants but require solid execution skills. Market insiders know that fresh cash seeks opportunity at the start of the day and paint the tape to encourage execution. This premarket manipulation encourages supply-demand imbalance because many traders see these numbers and place ill-advised orders well above or below the market. The resulting friction sets the stage for a violent reversal just minutes into the new session.
Most morning gaps face a testing period before filling or yielding to a trend thrust. Fades can begin as early as the opening bell. But price often moves first in the direction of the gap to gather volume before it reverses by the third 5-minute bar. This classic reversal zone originates from the era when most public participants had to view the markets through a 15-minute delay. Insiders held opening price firm to give this retail crowd a chance to act before fading them.
Gaps encourage execution tactics that favor or fade the open. The highest-risk tactics enter a new position at the open in the direction of the break. As with other momentum plays, price can fade sharply without a clear signal that the trade should be terminated. Execution against the gap after a two-bar thrust offers lower risk but more anxiety. This countertrend tactic requires defensive management after execution and a very quick exit or tight stop as price moves into a profit. The setup also demands cross-verification with central tendency tools. The opening bars must thrust well outside short-term Bollinger Band extremes before consideration of a fade position.
Look for a bounce at the prior closing bar if price breaks opening congestion and reverses to fill the gap. As the market pulls back, the opposite end of the hole now presents a new barrier. A reversal off this level sets the stage for price to fail and thrust well back into the prior closing range. Gaps that stay unfilled signal powerful support or resistance. Price should eventually push out of the morning range into higher or lower levels when this occurs.
Early congestion identifies signposts for safe gap entry. These range extremes provide important information on the strength or weakness of the morning move. Gaps that fill quickly should be avoided in the direction of the trend. Use classic swing strategies to prepare execution after they test and hold. In other words, buy pullbacks in up gaps and sell bear rallies in down gaps. Also consider breakout strategies at the high or low for the session. For example, look for a second test of a short-term top and enter in expectation of a breakout.
Long entry into a big market gap down terrifies many swing traders. But this profitable opportunity must be mastered to achieve consistent performance. Learn to set aside fear and stand against the crowd when the right conditions present themselves. Reprogram your natural reaction to stomach-churning down gaps by stepping in the shoes of those trapped on the other side of these shock events.
Market professionals use fear to generate profits. Many opening gaps allow large players to benefit their own accounts by fading the crowd. When overall conditions favor strong buying interest, these shock gaps actually represent low-risk entry for the swing trader. Learn to interpret this market sentiment correctly and capitalize on misinformed sellers.
But extreme caution is advised. Only an experienced swing trader with a solid history of risk management should execute a long position into a down gap. Poorly timed gap entry can be very deadly to an equity account. Avoid execution right at the open whenever possible. Instead, watch for cross-verification near the third-bar reversal and find a small pullback for immediate entry. Also check the news first to evaluate the severity of the shock event. The best opportunities come when no obvious reason drives the selloff.
Risk-averse traders can also find profitable opportunities on these fearful mornings. Watch for a first rise pattern back to the closing hour high of the prior session. This price action signifies a filled gap and the first stage of a reversal that should carry higher. Treat this simple price test as a double top and watch for a long opportunity on the next pullback or third rise into the extreme.
Ascending triangles print the most bullish patterns, while descending triangles form the most bearish ones. Symmetrical triangles display a zero bias for either outcome: the formation suggests a state of perfect balance.
However, the dependability of all patterns mutates with the crowd’s participation. The most perfect and widely recognized triangles will cause the most grief for those trading in the direction of the common knowledge.
Triangles give birth in a state of high volatility. This agitation decreases sharply as they approach their termination points. This poses one of the risks inherent in trading these patterns. Volatility may flatline if no ignition sparks a breakout. This forces price to meander endlessly in sideways motion and lose its potential. Close out positions without hesitation when caught in this phenomenon.
Buying pressure builds in ascending triangles as price tests upper boundaries. The setup normally triggers on the third rise to the top. A sharp expansion through this horizontal zone signals the breakout. Watch for a failure at the third high that may print a triple-top reversal. The best patterns show precise horizontal resistance. This builds strong demand just above that level. Slowly ascending highs do not characterize these bullish triangles. They represent bearish rising wedges. The difference lies in the loss of buying power as each nominal high fails to produce a significant profit.
