Swing Trading For Dummies Cheat Sheet

Swing trading can result in significant gains for your portfolio but involves risks that must be managed. Not every day is a good day to swing trade because the market may not be cooperative. And even when the market is cooperative, you should only trade stocks in strong industry groups to maximize the chances of success. Which stocks you buy depends on properly applying technical and fundamental analysis and only pulling the trigger when a positive catalyst exists. Finally, your risk management system should protect your portfolio when you are wrong, while allowing profitable trades room to grow.

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Assessing industry strength for use in swing trading

Being a successful swing trader calls for many skills, including the ability to assess the relative strength of various market sectors. Assessing sector strength is not only applying technical analysis to the ratio of a stock’s industry group and the market index, but also involves determining the stage of the economic cycle: early recovery, full recovery, early recession, and full recession. Different sectors outperform the market during different stages of the economic cycle. This chart helps you determine which market sectors lead at different stages of the economic cycle.

Signs you've found a good candidate for a swing trade

No trade is a sure money-maker. However, that does not mean you should not take every step to ensure the highest probability that every trade you put on is successful. Increase your chances of success by ensuring your trading candidates meet most — if not all — of the following conditions.

• The market is on your side: A rising tide lifts all boats. Before you buy, make sure the public equity market (for the country where you are buying the security) is in an uptrend by reviewing the monthly, weekly, and daily charts of the overall market index (see Chapter 10) .
• ‍The industry group is on your side: Stocks tend to follow their industry groups up or down. If the security’s industry group is a strong uptrend, chances are your purchase will be profitable.
• If you’re trend trading, buy on a technical signal or a breakout of a chart pattern: The stock should be entering an uptrend (from a chart pattern) or resuming an uptrend on a technical signal. Enter on the day of the signal (or the day after at the latest) and not one week after. Use the ADX indicator to determine whether a trend exists.
• If you’re trading ranges, the candidate should have just bounced off of support with a technical indicator confirmation: Watch for the technical indicator (an oscillator) to generate a buy signal. Divergences between your oscillator and the price action signal higher-confidence trades (for example, a stock falling to a support level while the oscillator, such as stochastics, traces a higher low and indicates underlying strength).
• Only buy Bucket 1 stocks: Pair your great chart setup with strong fundamentals.  Follow the methodology outlined in Chapter 8 to estimate a company’s value using normalized cash flows, the appropriate multiple (based on industry, profitability, and growth measures), and reflecting cash and debt levels. Focus on Bucket 1 candidates — stocks with upside of 50 percent or more.
• Only buy when a positive catalyst occurs: Stock movements on no news are often noise; no sustainable trend is likely to follow. Buying a stock on the day of or the day after a positive catalyst — such as a surprise positive earnings report — is more likely to be a profitable trade. Limit all purchases to stocks with meaningful positive catalysts (see Chapter 8).

How to manage your risk when swing trading

The most important determinant of whether you’ll be a successful swing trader is how well you manage risk. Ask yourself these questions before placing a trade to ensure you don’t cut corners:

• Is the security liquid? (If not, pass!)
• Is thesecurity a penny stock? (If so, pass!)
• Are you prepared to limit losses at the individual stock level? Determine which precautionary measure you'll take:
  • Set the position size based on the percentage you’re willing to lose (0.25 percent to 2 percent of total assets).
  • Set the risk level as a straight percentage of assets and that percentage doesn’t exceed 10 percent of your total portfolio.
• Is your portfolio diversified? Make sure your positions are spread among different market capitalizations (for example, large cap, mid cap, and small cap), different sectors, and different countries. But do not overdiversify (say, holding more than 20 positions).
• Have you limited your total portfolio losses to 7 percent? Cover all your bases by confirming that
  • Each security in the portfolio has a risk amount equal to the difference between the current price and stop-loss level (the amount at risk falls to 0  if the stop-loss level has been raised to a level above the cost of the trade).
  • The difference between the purchase price and the stop-loss level on an individual security level is tight — around 0.50 percent of the portfolio value.
  • The sum of those differences (between cost and the stop-loss level) doesn’t exceed 7 percent of the total portfolio value.
  • Raising stop-loss levels allows you to risk more of your capital since the amount “at risk” can fall to 0 if the stop-loss level is at a level representing a profit (barring a gap in prices, of course).