Over the last few weeks we’ve covered some of the big trading themes to keep an eye in 2014… We considered the outlook for Gold, we got the Binary Options strategy test underway, and we talked about the latest developments in Crypto-Currencies…

In this week’s issue I’d like to get back to some hands-on trading.

We’re going to cover a nice simple way to trade the medium term timeframe – the daily chart.

And the idea here is to focus on a timeframe that displays the core directional movement of the market. We want to avoid getting tangled up in the little quirks and characteristics the markets go through during the smaller, intraday timeframes.

And don’t get me wrong, there’s nothing wrong with zooming in closer and taking quick-fire day trades – we’ll be covering plenty of that kind of activity in other issues.

But today we’ll be trading in a more laid-back way… with fingers clicking, and toes tapping, we’re trading the Swing, baby. Yeah!

What is swing trading?

As far back as 1908, Charles Dow – inventor of the Dow Jones Industrial average, and founder of The Wall Street Journal – described a method of trading “in active markets, taking many trades, and relying on stop loss orders for protection”.

It’s what we know today as Swing Trading.

The opportunities come in either direction – we can buy or sell the market regardless of what the longer term trend is. And it’s all about anticipating the immediate move – the very next Swing in price.

You can sit back and ask ‘what is the market likely to try and do next?’ and then figure out what the high-probability trade is, based on that analysis.

A typical example would be where the market breaks out to new highs after testing overhead resistance…

The high-probability trade would be to enter a long position – be a buyer – the next time the market takes a little dip. This is because the momentum is still with the Bulls (the buyers). They overcame the selling pressure, the first dip down is likely to be caused by some quick profit taking, and probability now favours a continuation back in the direction of the breakout.

Once you’re in a swing trade, the priority is to turn the trade into a low-risk proposition. By choosing the entry points to your trades carefully, you can usually get in during a sharp move as the market takes a run at breaking out again. It lets you put a tight stop loss in behind your entry and quickly pull the stop to break even for a low risk trade.

It means we’re not really trend following here. There’s no allowance for any breathing space with these trades. We want the market to give us a short, sharp profit – I’ll tell you about finding profit targets in a moment – or we want it to quickly prove our analysis wrong… preferably only after we’ve had chance to move the stop to break-even!

Here’s a simple three-step Swing trading process for you:

1) Find an eye-opening event

First of all you want to find a price-action pattern that suggests either a change in bias – a potential reversal – or one that anticipates a continuation of the current market direction.

And the world of technical analysis is at your disposal here… choose any of your favourites (you can even specialise in just one of them and still be a very successful swing trader) – you can look out for double tops, head and shoulders patterns, breakouts to new highs, doji reversals… you name it.

(If any of the price patterns I mentioned are new to you, or if you’d like to explore deeper, I’d recommend Murphy’s Technical Analysis of the Financial Markets as your go-to reference book.)

Next, once you’ve had your eyes opened to a potential opportunity, you monitor for a confirmation. You now want to see a pullback before you attempt to enter the trade.

2) Pullback and Entry

Most successful Swing trades will occur in a high-momentum environment – once the market has already indicated its next probable move (through the eye opening event).

Your job is to now patiently wait until the market makes a small pullback or pause. This gives you chance to enter a trade strategically, with a carefully calculated (and very limited) exposure to risk.

In our example of a breakout to new highs you patiently wait until the initial volatility dies down, the move higher slows and eventually pauses for at least a bar. You’re now poised to enter your long trade once the market continues higher – above the ‘pause’ bars.

You can do this by leaving a stop-entry order working with your broker that gets you into your position automatically. You don’t need to sit watching.

Next, once you’re in, you need to manage your trade with a Target and Trail exit strategy…

3) Target and Trail

You’ve found an eye-opening event, you’ve had it confirmed by the little pause or pullback, and the market now looks ready to soar again to new highs…

You can use a retest of the recent breakout high as your first technical target – it’s the logical place for the market to strive to reach next.

By doing so, you’re letting the market prove it’s going to try and do what you suspect. You’ve got a high probability initial target to use to take some fast profits and you can also use that as your signal to move your stop to break even.

So let’s pull all the theory together now and look at the chart for an example swing trade… We’ll be looking at the Japanese Yen (USD/JPY) daily chart for this one.

First of all, this is the eye-opening event… it’s a recent breakout above highs from last summer:

USD/JPY Daily Chart

And here’s a close-up of the swing trade in action:

A = False breakout. The market takes out the highs but can’t keep it up there. No opportunity yet.

B = Here’s the eye-opening event. The market breaks out above the old highs and holds its ground. We’re now waiting for the pullback as confirmation to try and enter a trade.

C = Here’s the pull back. We want to enter on a breakout above the bar labelled C with an initial technical target of the highs of the bar market B. That’s where the market will try to reach as a first port of call.

Here’s a close-up of the trade management:

The entry point is a break above bar C. The initial target is the high of bar B – the market will try to go there to keep the up-move intact.

Your initial stop in this case could be placed below the bar marked C. (I would suggest using a default 1:1 risk/reward ratio in cases where stop placement is not obvious from the price action alone.)

You can see the thrust upwards after entry into this trade…
It takes out the target within three bars – a 53 tick move. And once the target it reached you should seriously consider taking some money off the table and trailing your stop up to breakeven at least. The move may continue upwards for days to come – but who knows for sure?

Remember we’re after a quick, solid result on these Swing trades. We know the high probability move is from C to B but after that… don’t risk watching your paper profits disappear by holding out for too long!

The same principle works for whatever eye-opening event you’re trading… wait for the confirmation pullback after the event has taken place, and then simply look to get your hands on that first chunk of high-probability profit.

Be Prepared: Market Moving Data Coming This Week (London Time – BST)

Wednesday 29th January:
12:15 UK BOE Carney Speaks GBP
19:00 US FOMC Statement/Interest Rate Decision USD

Thursday 30th January:
13:30 US GDP USD
15:00 US Pending Homes Sales USD

Friday 31st January:
10:00 EUR Euro CPI EUR
10:00 EUR Unemployment figures EUR

I hope you enjoyed this week’s issue. Let me know you go on with your own swing trades. The good thing is there’s always something swinging in at least one of the currency markets!