Swing Trading with Spread Betting
Swing trading is a powerful technique used by spread betters and other traders to buy on the dips and sell on the tops.
In broad terms, swing traders aim to profit from the upswings and downswings in the market, identifying rally tops to sell into and troughs in price declines in which to buy. The generally accepted view is that the risk/reward trade-off is at its most favourable when both the mini and major trends are moving in the same direction, namely when buying at the bottom of the dips in a well-defined uptrend or when selling at the top of the rallies in a well-defined downtrend.
There is no universally accepted and defined method of swing trading. Instead it is more of a practical trading style that can be applied across the board to markets as diverse as equity indices, currencies and individual large-cap stocks. Since it works equally well in different time frames, it is just as relevant to day traders as it is to position traders. The advantage of using spread bets to swing trade is that having the scope to place both up bets and down bets makes it possible to exploit the peaks and troughs alike, although active day traders will probably find it makes more sense to use CFDs.
A swing trader tries to profit from longer term (although still relatively short term – days or weeks) trends and riding them until they run out. Typically, he will enter and exit a position a number of times, depending on the market movements. This provides an effective trading system for buying low and selling high.
Markets spend a lot of time churning around, especially in the smaller time frames, and these sort of choppy sideways conditions within established ranges are perhaps the best in which to look to exploit the swings. Take the scenario of a move up being halted by profit-taking. The swing trader who believes the bigger trend is up will want to buy on this dip when both the major and the mini trends are moving in the same direction. The problem from a psychological perspective is that it can be difficult to sell into strength and buy weakness, since the markets always look bid at the top and offered at the bottom. That is why a swing trader needs a systematic plan to identify the optimum entry point and stop loss level, together with the discipline to stick to it.
Spotting the peaks and troughs (swing trading points)
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There are various practical ways of identifying the swing points at which to trade. Momentum indicators such as the moving average convergence divergence (MACD) and the relative strength index (RSI) are good in a sideways market. For example, using an RSI indicator it is more prudent to buy or sell against the immediate trend when the market is overextended, namely when the RSI enters overbought territory above 70 or an oversold area below 30.
This signals that there is likely to be a correction before another strong price move takes place. If a daily RSI is moving towards oversold, switching to an hourly RSI on an intraday chart could help to finesse the actual timing of the trade.
Do not try to ‘predict’ which way the stock market will move next. Instead, allow the market itself to determine your actions. All stock prices represent a ‘perception’ of value – what the crowd/market ‘think’ stocks are worth. All perception of value is based on ‘moods’, which swing like a pendulum between positive and negative. To align yourself into these rhythmic cycles, is the same as allowing the market itself to provide clues, and determine your actions absolutely.
One of the classic ways to swing trade with a daily bar or candlestick chart is to use the major Fibonacci ratio points. The chart of the Australian dollar against the US dollar shows a recent example. Steve Hatton, chief analyst at CMC Deal4free, explains: ‘In February we saw a potential hammer reversal candlestick [a day with a new low and a close at the top end – often a good bottoming signal] occur at the 50% and 62% Fibonacci retracement zone within the final phase of a triangle formation. Oversold conditions as indicated by the RSI within this consolidation phase reinforced the idea of a basing action, the buy signal being the break above the high of the low day with the stop placed below the low bar.’
Clearly it is safer to sell into a rising market if there is a strong layer of prior resistance and vice-versa. This is especially applicable when shorter-term price moves encounter multiple layers of support or resistance evident in the daily/weekly chart. The dollar/yen chart highlights the use of support and resistance to help determine the swing points. ‘The breach above 105.20 and 106.20 resistance in February provoked a strong one-day surge in the exchange rate,’ says Hatton. ‘However, with the dollar nearing important resistance at 107.00/30 and a double Fibonacci area, together with the daily RSI entering a severe overbought zone, there is a risk that this is a topping area.
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Markets spend a lot of time churning around, especially in the smaller time frames, and these sort of choppy sideways conditions within established ranges are perhaps the best in which to look to exploit the swings
‘The subsequent close back below 106.20 and rejection of the high reinforce the idea of a swing high, with the break below the low of the high day signalling the likely onset of a reversal. Stops would ideally be placed somewhere just above the pivotal 106.20 high with targets being either the length of the high bar or a 50% retracement area.’
Robert Newgrosh, a seminar trainer sees swing trading as a technique for capturing moves of anything from two days to two weeks. He uses it to get an entry into a medium term trend, for example, trying to catch the next up swing in a medium-term uptrend following a retracement.
The idea is to enter the market at a point when the ongoing trend is about to resume. ‘If the market closes near its high then this is a good indication that the medium term trend will continue the next day,’ he says. ‘However its dangerous to enter the market just on the back of one day’s data, instead I would always look at the bigger picture and check for support or resistance before deciding on a trade.’
Newgrosh covers techniques that are suitable for swing traders on his courses but doesn’t have a seminar devoted purely to this area. See www.new-skills.co.uk for details. Conor Ringland, head of E*Trade Professional, says that swing trading is used by a lot of day traders, primarily because it encourages discipline with both entry and exit strategies. ‘On a chart with an upwards channel there is every probability that an undisciplined trader would jump in at the top of the rally,’ he explains. ‘A swing trader however would confirm the direction of the trend and then wait for the correction before trading. Typically they would look for three lower bars (lower high, lower low) with the entry being the break of the high of this correction and the stop being set at the low.’
Ringland is a fan of Marc Rivalland, the respected swing trader who has developed his own system to identify mini corrections within the main trend. Rather than looking for three consecutive corrective days, as Gann suggested in his classic three-day swing chart, Rivalland looks for three that are closely bunched, which for an index means within eight trading days.
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Rivalland publishes his analyses of the FTSE, Dow and the NASDAQ on his website www.marcrivalland.com, although this should not be viewed as a stand-alone trading tool. At the time of writing, the last signal on the FTSE was a buy given on 22 December when the index passed the 4755 level. This was the high created during the three-day correction period of Friday 10, Monday 13 and Tuesday 14 December – each of the three being up days (higher highs and higher lows) that together signified the end of the mini correction in the major uptrend (see chart).
In terms of an exit strategy, Rivalland sets himself a target profit level. ‘The swing trading methodology is opposed to the idea of running profits and cutting loses,’ he explains. “The only way to be sure of making money is to capitalise on the swings when they work, which is why I look to take profits of between 2.5% and 4%.’ Rivalland has migrated much of his trading to spread bets and says that the key when swing trading the indices is to use a company that quotes tight spreads. The most competitive tend to be around the three or four-point mark, which is important for those traders who are looking to take out moves of maybe 30 or 40 points from the market. He runs regular seminars where he explains his trading technique.
The swing trend scan identifies stocks that are just beginning to trend while the oscillator scan uses popular indicators such as the MACD and stochastics to identify overbought or oversold securities.
‘I use swing charts as the primary method to identify trends and point and figure as a backup,’ he says. ‘The bullish breakout buy signals from the P&F charts of the S&P, FTSE and the DAX that emerged just as the Dow hit its low for 2004 at the end of October helped me to get in right at the bottom of the market.’
Swing Charts
The choice of chart type is very much a case of personal preference and many elect to use a normal bar or candlestick chart in conjunction with a set of indicator overlays to identify the swing points. The same data can also, however, be used to produce a swing chart, which is specifically designed to support this type of trading technique.
There are many different ways to construct these but one of the most popular is the Gann swing charting method, which uses the highs and lows as distinct from the opening and closing prices. In particular it identifies the beginnings and ends of trends – the time to enter or exit a swing trade – respectively as an up day (higher high and higher low) followed by a down day (lower high and lower low)and a down day followed by an up day.
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The chart is actually constructed by moving these points together in equal intervals (while maintaining the order) and connecting them together to give a step-like pattern. This makes the market trends easier to see as both the time factor and the market noise are removed (see chart).
The example taken from Hot Trader, a specialist Gann swing charting application, shows a split-screen display of the swing chart on the FTSE alongside the corresponding bar chart. Small horizontal lines on the swing charts indicate the points where the swings are confirmed and the corresponding points are marked with a dot on the bar chart to make it straightforward to relate one to the other.
The software also includes a useful Hot Scan feature that can scan the database of securities using swing trends and oscillators. The swing trend scan identifies stocks that are just beginning to trend while the oscillator scan uses popular indicators such as the MACD and stochastics to identify overbought or oversold securities. Hot Trader is available from various re-sellers including www.paritech.co.uk, where it costs £200 on its own or £320 with either US or LSE end-of-day data.
W.D. Gann
The classic three-day swing chart was invented by the legendary trader WD Gann. His trading methods coupled with a highly disciplined approach generated big profits for him back in the 1930s. In fact, despite his famous forecasting ability, Gann is reputed to have made most of his money through what he called his mechanical trading method, namely trading with swing charts. The idea behind swing trading is to identify the major market.
It is of course always essential to use a stop loss when spread betting or embarking on any other form of margin trading
trend and also the mini corrections to it. In an up trend the principle is to buy on the dips as soon as the correction is over, and in a downtrend to sell the rallies as soon as the correction has finished. This ensures that both the major and minor trends are moving in the same direction as the trade. Such a strategy mirrors Gann’s view that to make profits, traders have to follow the trend and change when the trend changes. The same idea is often expressed today through the expression: ‘The trend is your friend.’ Swing charts were Gann’s way of actually implementing this.
In going from a bull market to a bear market, Gann said that after a prolonged advance when the security reaches a final high, there is usually a short but severe decline lasting one, two or possibly three weeks or maybe even months.
The market may then remain in a narrow trading range before experiencing a secondary bull rally. Gann’s swing trading method identifies the trigger point for the short sell as coming after this rally when the stock breaks the swing low, namely when the stock breaks the bottom of the last reaction. At this point both the minor and major trends are falling.
Moving from a bear market to a bull market follows the same principle, albeit in reverse. After the bear market ends, Gann said that there is usually a rally lasting anything up to a couple of months and then a reaction back down again, making a higher bottom. The buy point follows when both the minor and major trends are rising. The three-day swing chart reflects Gann’s view that the first correction should last for at least three consecutive days. In an up trend this means that each day of the correction should have a lower high and lower low than the previous day. In a downtrend it is the opposite – a day with a higher high and higher low than the previous day. It is the highs and lows that are important.
Patterns are fine for deciding entry points, but when it comes to the exit strategy there are basically three options: waiting for a specific signal – which incidentally may never happen – setting a target profit level; or using a moving stop. The advantage of using a target profit level is that on a long position for example, the position would be closed by selling into strength. Likewise the problem with triggering a stop is that the market would be moving against the trade when it is closed.
It is of course always essential to use a stop loss when spread betting or embarking on any other form of margin trading. If used appropriately, stops will help ensure that potential losses are sustainable when things don’t go according to plan. Equally though it is important not to set them too tight so as to prematurely close out a position.
One of the attractions of swing trading is that it naturally highlights two potential stops. With a long position this would either be under the low of the signal day or under the closing price of the previous day. Gann’s original three-day technique involved far wider stops than most would feel comfortable with today. For example, in an uptrend he would continue to move his swing chart up until there were three consecutive down days. As a closing note it is probably much easier to learn the mechanics of swing trading from trading purely equities.
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