Omar Bassal, CFA

Cheat Sheet / Updated 02-19-2025

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.

Article / Updated 09-25-2024

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? Is the security a penny stock (hopefully not)? 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 asset classes (not to mention domestic and international securities). 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 difference on an individual security level is tight — around 0.50 percent. The sum of those differences doesn't exceed 7 percent of the total portfolio value. The stop loss levels are at a level representing a profit (barring a gap in prices, of course). Cut losses when your stop loss is hit — no questions asked.

Article / Updated 09-25-2024

Being a successful swing trader calls for many skills, including the ability to assess the relative strengths of various market sectors. If you determine which stage the economy is in and then use that information as you review the following chart, then you’ll have a good idea which economic sectors are likely to lead the market in the near future.

Article / Updated 09-11-2024

To succeed with swing trading, you need to know how to read market indicators. Make a swing trade that’s more likely to yield good results by getting to know the following signs of favorable conditions. (Just keep in mind that no trade is a sure money-maker.) The market is on your side. A rising tide lifts all boats. And before you buy, make sure the public equity market (for the country where you are buying the security) is in a solid uptrend. 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. Use the ADX indicator to determine whether a trend exists. If you’re trading ranges, the candidate has just bounced off of support/resistance 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). The fundamentals back the technicals. Pair your great chart setup with strong fundamentals. And no, you don’t need to spend 25 hours reading a company’s financial statements. Simply verify the important items, such as financial health, return on equity, P/E ratio, and expected earnings growth rates. The stop-loss level is near your desired execution price. The best swing trading candidates are those where your emergency exit is nearby. The closer your desired entry price is to your stop-loss level, the less you stand to lose if matters turn ugly. But don’t place your stop loss at a level so close to the market price that a small insignificant move forces you out (as with most things in life, there must be a balance). You allocate the right amount to the trade. Loss is always possible, even with the best swing trading candidate. Set your position size in accordance with your trading plan, which should put an absolute ceiling on your position size and set a maximum percentage of capital you’re willing to lose on a single trade and for the entire portfolio (remember, shark bites versus piranha bites).

Article / Updated 12-21-2021

In swing trading, stock traders hold an asset for one or more days, hoping to profit from price changes or "swings." Swing trading can and should be enjoyable. But swing trading is still a business, so you must stick to certain rules designed to keep you in the game. After all, if you have no capital, you can’t trade. So, the most important rule is the rule of survival. Surviving means not only managing risk but also following your own plan and your own rules. Trade your plan Your trading plan is your road map. It answers the following questions: What are your goals in trading? What is your time horizon? What will you trade? What tools will you use to trade (technical, fundamental, or a combination of the two)? How much capital will you allocate to your positions? What are your entry signals? When do you exit a position for a profit? When do you exit a position for a loss? Trading plans must be carefully thought through and then written down. Here's a sample questionnaire in the following figure to help get you started on following your trading plan. Your trading questionnaire may be more or less complex than this sample. Either way, having such a questionnaire forces you to think through the important issues you may overlook when you’re making decisions on the fly. Stick to a trading questionnaire, as silly as you may think it sounds, and you’ll find the success of your trades increasing. The more errors you avoid, the more likely your trades will turn out profitable. Follow the lead of the overall market and industry groups If you’re trading stocks, you want the wind at your back, meaning your trades should be in the direction of the overall market. If the market is in a strong bull market, then you should be close to fully invested. And if the market is in bear mode, you should be holding cash (or seeking bull markets in international markets). Markets may also be stuck in trading ranges, in which case you should opportunistically buy strong setups while avoiding too much risk given the lack of market direction. But trading with the overall market is only part of the story. The skilled swing trader recognizes that industry groups make a difference in a security’s returns. When an industry group is in the top of the pack (as identified in High Growth Stock Investor software or eTables by Investor’s Business Daily), the stocks in that group are likely to follow suit. Conversely, when an industry group is in the bottom of the pack, the stocks in that group are likely to follow suit. When tech stocks fell out of favor in late 2018, most all tech companies were affected irrespective of their fundamentals (see the examples in the following figure). Most securities in the technology industry fell in unison in late 2018 given high valuations and fears of an economic recession. The industry group in which you trade is more important to your success or failure than which company you pick in that industry group. So, as a swing trader, concentrate purchases on industry groups that are in the top 20 percent of the market. You can also identify promising candidates in industry groups gaining strength (either by examining the industry group chart or by examining groups with increasing group strength). Don’t let emotions control your trading Humans are affected by emotions. But allowing your emotions to rule your trading decisions can be disastrous. In fact, emotions can be your biggest enemy. In a sense, you are your own worst enemy. Traders who lose billions of dollars at major banks often start out losing a small amount and then try to break even or prove themselves right. Their ultimate failing lies not in their analysis or their market knowledge but in their inability to control their emotions. The markets aren’t personal. When you lose money, it’s not because you made money last time. Your losses and profits are a function of your trading ability and the markets in which you trade. The true, professional trader is a master of his or her emotions. Profits don’t lead to extreme joy, and losses don’t lead to extreme pessimism. If you sat across the table from a professional trader, you wouldn’t be able to tell whether they were up $50,000 or down $100,000. Professional traders are calm and don’t let their emotions take over their cognitive functions — they have trained themselves on how to manage their emotions. Another factor in controlling your emotions is keeping tabs on your trades. Don’t brag to others about your profits. Don’t tell others about any trades you’re in at the moment. Do so and you become married to your positions. If you tell your best friends that you hold shares in Company A and you believe the share price is going to skyrocket, you’ll be less likely to exit if the trade turns down. “Oh no!” you may say to yourself. “Everyone knows I hold Company A. I can’t bail now. I’ve got to hold to prove I was right.” Controlling your emotions isn’t something that just happens one day and you never have to worry about it again. Rather, it’s an ongoing battle. The two strongest emotions you’re going to face are greed and fear. When markets are roaring in one direction and you’re riding that wave, you’ll want to hold positions longer than you need to as you amass more profits. And when markets roar in the opposite direction and your profits evaporate, you’ll want to take more risks to make up for those losses. You can’t battle these emotions in any scientific way (that I know of, at least). I’ve always imagined that a Spock-like character who’s always rational and never lets emotions interfere with his trading would make a wonderful trader. Unfortunately, Star Trek is a fictional story, and Vulcans don’t exist. So, as a trader, you need to review your trades carefully and practice being calm as much as possible. Be disciplined enough to force yourself to stop trading if you detect your emotions are driving your trading. Diversify, but not too much As a swing trader, you must hold a diversified portfolio of positions. You should have at least ten different positions, and they should be in different sectors. And if you can, incorporate other asset classes in your swing trading. For example, include technology stocks, developed market equities, emerging market equities, and ETFS Physical Gold (assuming these securities meet the fundamental and technical criteria of your strategy). All of these positions represent different ways to diversify your portfolio. Holding more than one position reduces idiosyncratic risk (a fancy way of saying the risk attributable to an individual position). And diversification allows your portfolio to withstand market volatility — the gains from a few positions can offset the losses from others. But too much of a good thing can harm you. It’s possible to diversify too much — holding say 30 or more positions. A swing trader needs concentration to make large profits. The more positions you hold, the closer the returns of the portfolio will be to the market. Manage risks: Set your risk level Setting your risk level goes hand in hand with setting a stop loss level. Entering a stop loss level is an order entry step, but setting a risk level is an analytical part of the process. Your stop-loss order will often be at the risk level you identify in this step. Your risk level represents the price that, if reached, forces you to acknowledge that your original thesis for trading the security is wrong. You can set your risk level based on some automatic percent level from your entry order, but I don’t recommend this because it forces a reality on the market where one may not exist. For example, say you automatically exit a position when a security declines by 5 percent. But why should that security stay within this 5 percent range? What if the security’s daily volatility is 3 percent? It may hit your risk level in a day or two just based on normal volatility. For this reason, set your risk level based on support or resistance levels. If a stock finds support at $20 frequently, set your risk level at $19.73, for example. Don’t use a whole number for the risk level, or you may place your stop-loss order at the same price that hundreds of others place their orders. Instead, for instance, use something like $67.37 rather than $68 if that is the support level. Your stop loss level should be set at your risk level. But formulating your risk level depends on what your trading plan calls for. If you don’t want to use some obvious support level, then use a moving average, but be prepared to constantly adjust your stop loss level because the moving average is constantly changing. The wider your risk level is (that is, the farther your risk level is from your entry price), the smaller your position size should be. This rule of thumb ensures you aren’t risking more than 1 to 2 percent of your total capital because you may be entering a security that’s extended. Swing traders who focus on trading ranges have an easier job of identifying their risk levels. They’re looking for a continuation of an existing trading range. Hence, a breakout above or below a resistance or support level would signal the end of the trading range. That resistance or support level is the most obvious risk level for the swing trader. Manage risks: Set a profit target or technical exit Your profit target is often based on a previous support or resistance level. Some swing traders set predefined profit targets of selling 50 percent of a position after it achieves a 5 percent gain from entry and selling the other 50 percent after it reaches a 10 percent gain. When trading based on a trading pattern like an inverse head-and-shoulders pattern, your profit target may be determined by the projection price implied in the chart pattern. My preference in taking profits is to rely on a signal from a technical indicator rather than a pre-existing support or resistance level. Some securities trend longer and farther than anticipated, and they can be very profitable. So, I prefer to exit after a security breaks below an indicator, such as a moving average, or on a sell signal from a trending indicator. The one exception to this rule is for a security that achieves a significant gain in a short period of time. In such cases, selling a portion for a profit and the remainder on a technical signal makes sense. Use limit orders When entering or exiting a trade, you should use a limit order rather than a market order. A limit order ensures that your execution occurs at the price you specify, whereas a market order can be filled at any price. Rarely will you encounter such urgency to get into or out of a trade that you’ll need to enter a market order. Moreover, you’re unlikely to buy at the bottom of the day or sell at the top of the day. So be patient and you may get a better price than you originally thought. Another reason to use limit orders is to help you avoid the cost of market impact. The larger your order size is relative to the average volume that trades in the security on a typical day, the more likely your buy or sell order will move a security’s price higher or lower. A market order in a thinly traded stock may leave you with an execution that’s 2 to 5 percent above/below the price the security was when you entered the order. You can place a limit order at a price level near where shares have traded. The intention is to control the average cost per share. Place a limit order slightly below recent trades (when you’re buying) or slightly above recent trades (when you’re exiting). Recognize that there’s always the possibility your order may not get filled. But remember that your job is to be patient and execute your trade only when the timing and price are right. Use stop-loss orders You may think that stop-loss orders are nothing more than training wheels. “I’m an adult. I don’t need these pesky stop-loss orders. I can exit when I see weakness.” Unfortunately, that kind of thinking may get you killed (financially speaking, of course). Financial markets aren’t playgrounds or appropriate places to find out who you are. Leave that to your local sports club. Stop-loss orders are necessary for several reasons — even if you watch the market 24 hours a day, 7 days a week: They help you deal with fast-moving markets. If you swing trade ten different positions, it’s quite possible that many of them may start acting up on the same day. And they can move fast and furious if negative news is in the air. Because of the speed at which markets move, you need a stop loss to save you if you’re unable to act. They limit your downside. Without a stop-loss order, your downside may be all of your capital. Stop-loss orders act as protection, because they place some upper limit on the losses you may suffer. Of course, a security could gap through your stop-loss order, but your loss would be realized then regardless of whether a stop loss order existed. They help take your emotions out of the game. When you place mental stop-loss orders, you may start to arbitrarily move your imaginary stop loss as the markets move against you. So, you plan to exit at $49.50, but when the security trades through that price down to $49, you tell yourself that $47.50 is a more reasonable exit point given recent market action. You justify your change and you hold on. And your losses mount. They give you time to take your eye off the ball. If you travel or are unable to watch the markets on a day when you’re sick, stop-loss orders ensure that your portfolio value is preserved. If you didn’t have stop-loss orders, you’d probably fear ever being out of touch with your computer and the markets. One or two lousy positions can quickly change a top-performing account into a poor performer. For these reasons, stop-loss orders are essential. Keep a trading journal Trading journals organize your thoughts and the reasons behind your decisions. They should be updated after every trade you execute. If you delay entering a trade into your journal, the trades may eventually pile up and overwhelm you, and you may decide not to update the journal anymore. A trading journal is your coach. By recording the reasons you enter a position, you can review whether your assumptions are correct, and you can find out whether your trading plan needs adjustment. For instance, perhaps you always enter positions prematurely and need to incorporate some indicator to prevent you from trading too soon. Or perhaps you exit prematurely and leave significant profits on the table. A trading journal reveals such habits and patterns, and you can adjust accordingly. The fun part of keeping a journal is reviewing the major winners and major losers. I often learn more from reviewing my losers than I do my winners. I look to replicate the winning trades in the future and avoid the circumstances surrounding the losing trades. The more detailed your journal is, the more time you’re going to spend updating it (especially if you trade frequently). Sometimes using a screen capture program can cut down on the time. Screen capture programs allow you to capture a window on your computer and store it as an image that can be transferred to a Word document or Excel spreadsheet. You can take snapshots of the security’s chart and its industry group with small amounts of written text indicating how the security was found and what triggered the entry and exit. That can be sufficient for a trading journal. Have fun This final rule goes to the heart of whether you can be a full-time swing trader. You have to like the business. You have to enjoy spending hours on the computer looking for investment candidates. You have to find pleasure in reading books about swing trading. If you have to force yourself to research positions, then swing trading may not be for you. If logging onto your brokerage account is a painful exercise you prefer not to do because you feel ashamed, swing trading may not be for you. Even when you’re down, you have to be optimistic that your profits will come soon. And that optimism helps make those profits a reality. So, enjoy swing trading and all it entails. You’ll find it can be a rewarding experience — financially and otherwise.

Article / Updated 08-30-2019

Swing traders rely on a variety of products and services to analyze potential trades and stay sharp in their work. This article provides more details on the top ten resources. These resources aren’t necessities, but they do help you quickly identify financial securities and monitor their activity. Other resources keep you sharp on your game. Sourcing and charting your swing trading ideas Swing trading ideas typically come from bottom-up screening or top-down searches. MagicFormulaInvesting is a bottom-up screening website, and High Growth Stock Investor and eTables by Investor’s Business Daily are two top-down tools that can also do bottom-up screening. Trading ideas: MagicFormulaInvesting.com This website is very different from any you’ve visited. MagicFormulaInvesting.com is the brainchild of Joel Greenblatt, a successful hedge fund manager. The “magic formula” that the site’s title refers to is a simple quantitative ranking that Greenblatt developed. This formula assesses financial securities by two measures: A cheapness measure: Similar to the inverse of the P/E ratio An efficiency measure: Similar to the return on equity ratio Greenblatt, who wrote a book about this formula titled The Little Book That Beats the Market (published by John Wiley & Sons, Inc.), found that ranking securities solely on these two criteria generated a list of candidates that mightily outperformed the overall market. The formula is geared to long-term investors who are encouraged to hold stocks appearing at the top of the formula’s rankings and update holdings at least annually. Trading ideas: High Growth Stock Investor High Growth Stock Investor (HGS Investor) is a software tool that assists in identifying promising candidates to buy. The software incorporates both fundamental analysis data and technical analysis data. The software can be used to identify financial securities using both a top-down and a bottom-up approach. To assist you in identifying which industry groups to analyze, HGS Investor color-codes industry group rankings. Industry groups performing in the top 20 percent of the market are color-coded green. The next 20 percent of industry groups are color-coded yellow. The industry groups ranking in the bottom 60 percent of the market are color-coded red. HGS Investor also allows you to analyze commodities, dividend-paying securities, international securities, and value investments. Though some traders use HGS Investor for longer-term horizons than swing traders typically would, the software can be extremely valuable for the traditional swing trader. You can get a free trial of HGS Investor by visiting the firm’s website. An annual subscription costs around $700. Trading ideas: eTables by Investor’s Business Daily Investor’s Business Daily (IBD), unlike other newspapers, is geared to the swing trader. But the newspaper industry is a dying breed, and IBD has established powerful online tools that you should consider using. eTables is a service that allows you to review the best ideas from the editors of IBD (such as IBD New America or IBD 85-85, a list of securities with earnings per share and relative strength rankings of 85 or better). eTables also highlights securities that have just emerged from bases and may be ripe for purchase. The company’s philosophy is built around the top-down trading and emphasizes strong industry groups and strong stocks within those groups. The service favors growth-oriented securities over value-oriented securities. eTables can also assist you in selecting companies with strong fundamental and technical criteria, such as the following: Earnings per Share Growth Rating: This fundamentals-based ranking compares a firm’s earnings growth history to the other companies in the market. Relative Price Strength Rating: This may be viewed as a technical ranking because it compares the price performance of a security to all securities in the market. SMR Rating (Sales + Profit Margins + Return on Equity): eTables attempts to simplify fundamental analysis for you by crunching these figures and generating a grade of either A, B, C, D, or E. Accumulation/Distribution last three months: According to IBD, this rating measures “relative degree of institutional buying (accumulation) and selling (distribution) in a particular stock over the last 13 weeks.” Translated into English, this rating looks at whether big investors are buying shares en masse or selling shares en masse. Composite Rating: Finally, eTables publishes a Composite Rating that sums up a security’s score on the aforementioned criteria and adds in a security’s industry group ranking. The Composite Rating ranges between 1 and 99. You can subscribe to eTables by visiting the IBD website. Charting software: TradeStation You can find dozens of charting programs on the market. TradeStation is more than just a trading software tool. When the company was founded, charting and indicators were its bread and butter. TradeStation allows users to tap dozens of indicators that come prepackaged in the program or design their own trading indicators. By using those indicators, you can develop and backtest your trading strategies. TradeStation now incorporates brokerage with the charting platform. It allows users to trade public equities. TradeStation has won broker awards from the financial newspaper Barron’s and the trading magazine Technical Analysis of Stocks and Commodities. The TradeStation platform is free to brokerage clients who do a minimum number of trades a month (check with TradeStation to find out what that minimum is). Charting software: StockCharts.com StockCharts.com was founded in 1999 and offers users free charting services as well as premium services for paying members. Free charting features include the following: Three indicators per chart Three overlays per chart (referring to indicators plotted on top of the price movement) 900 pixels maximum chart width Members who pay a fee (ranging from $14.95 per month to $39.95 per month as of the date of this publication) receive the following benefits: 25 indicators per chart 25 overlays per chart Real-time data Larger charts Custom scans Custom alerts on individual stocks StockCharts.com also features a “ChartSchool,” which provides educational resources in charting analysis, technical analysis tools, and scanning tools. Doing market research for your swing trades Swing traders should always be sharpening their pencils. They should know what’s going on in the macroeconomic environment. For example, are interest rates high or low? Is the Fed concerned about inflation or economic growth? Is the U.S. dollar strengthening or weakening? You can keep abreast of these big-picture questions by staying on top of the latest news from financial publications. Real Vision TV Real Vision was launched in 2014 to disrupt financial media. The subscription-based website offers streaming videos of the brightest minds in investing, economics, and trading talking about their insights and opinions. All interviews on Real Vision are proprietary (you can’t access them on other platforms) and the interviews offered on the site are more in depth than comparable pieces on mainstream financial news networks (for example, an interview with a legendary trader like Jim Rogers may last two hours). Real Vision is an ideal resource to find out about different parts of the world and hear different views on topics like the likely direction of equity markets, currencies, interest rates, and so on. The site doesn’t cater to one type of trader or investor. Instead, you’ll find views from shot-term traders, long-term investors, and everything in between. When there is a new topic you want to read about (such as Bitcoin), Real Vision has experts debating the topic. You can subscribe to Real Vision TV for $180 per year. GMO Research GMO is an investment management firm based out of Boston and founded in 1977. As of the date of publication of this second edition of this book, the firm managed $70 billion. GMO is an institutional asset management company — meaning the firm manages money for large organizations like insurance companies, sovereign wealth funds, and pension plans. GMO is a fundamentally driven investment firm; the experts who work there are driven by extensive analysis of earnings, interest rates, valuations, and so on. Their investment horizon is measured in years, not weeks. In short, GMO’s calls on the long-term direction of markets are more often than not correct. They’re focused on larger moves than what may happen in the near-term. Because swing traders are focused by definition on shorter-term trends, it’s useful to expose oneself to the thinking of long-term investors who capture large, secular trends. Don’t expect that GMO’s free research will give you trading ideas. Rather, it’s useful to know the stage of the economic cycle and whether equities are expensive or cheap. That way when a swing trader sees trends emerging that align with the long-term picture GMO focuses on, she can position the portfolio to take advantage of the long-term picture. You can subscribe to the research for free. Keep tabs on your portfolio and the latest market news When you hold a portfolio of swing trading positions, you’re going to want to stay on top of them like a hawk. But how can you do that, aside from watching their prices change during the day? Monitoring your portfolio on a day-to-day basis can be cumbersome, especially as you hold more and more securities. Although setting alerts on your securities by using technical trading software (such as TradeStation, which I cover earlier in the “Charting software: TradeStation” section) is important, you should also keep tabs on any fundamental news developments that occur. Your brokerage provider should provide fundamental news on each position you own. The broker option is generally best because it automatically reflects your holdings and updates every time you buy a new position. Other paid subscriptions that can perform the same analysis include StockCharts.com. Free online tools are available that you can use to monitor your portfolio. Yahoo! Finance portfolio tool The easiest way I’ve found to keep tabs on all the news on my positions is to use the My Portfolio from Yahoo! Finance. This tool allows you to quickly enter the symbols of your portfolio holdings and even link the site to your broker or brokers’ systems. After the symbols are loaded, the tool pulls down any news headlines associated with those symbols, sorted by date, from such sources as Bloomberg, Reuters, and company press releases. By checking this website on a daily basis, you can stay on top of company announcements (such as earnings dates shown in the Events tab under the Calendars option in Markets) or positive/negative mentions of your securities in the popular press. And the best part is it’s free. To see the portfolio tool, visit Yahoo! Finance. Then click on the tab labeled My Portfolio. You may need to sign onto Yahoo! or create a Yahoo! ID to uniquely identify you and your holdings. After you’ve logged onto Yahoo!, you can edit or create portfolios on Yahoo! Finance. Yahoo! Economic Calendar On almost every business day, the federal government or private organizations release economic news that affects financial markets. Some of the information is very important (such as Federal Reserve Bank interest rate decisions), whereas other data points have little impact. To keep yourself apprised of the important stuff, turn to Yahoo! Economic Calendar, which provides a listing of all major economic news scheduled to be released in any given week. The website shows what data is to be released and what the market expects the data to be. The calendar even provides coverage for global markets (such as Japan, the United Kingdom, South Korea, and so on). Some data is released before the market opens, and other data is released during market hours. Yahoo! lists the time of each release — so keep in mind you may see some early hours for Asian or European markets. But how do you know when a report helps or hurts stocks? Follow these guidelines: Inflation: Generally, higher-than-expected inflationary data (in the form of the Consumer Price Index or the Producer Price Index) is negative for both stocks and bonds. Economic data: The growth rate in the country’s gross domestic product may be interpreted as bearish or bullish for stocks, depending on the stage of the economic cycle. If the economy is weak, then strong economic growth numbers are highly prized. However, if the economy is overheating, a strong economic report may send stock prices falling fast because investors will fear interest rate hikes that hurt companies’ profitability. Central Bank Actions: These actions (for example, lowering or raising short-term interest rates) tend to have the largest effects on financial markets. When the Federal Reserve lowers interest rates by more than market expectations, it generally leads to rallies in stocks and bonds. When the Federal Reserve raises interest rates by more than market expectations, it generally leads to declines in stocks and bonds.

Article / Updated 08-30-2019

Swing trading is the art and science of profiting from securities’ short-term price movements spanning a few days to a few weeks. Swing traders can be individuals or institutions. They’re rarely 100 percent invested in the market at any time. Rather, they wait for low-risk opportunities and attempt to take the lion’s share of a significant move. Generally, large institutional investors (think of a pension plan or a sovereign wealth fund) can’t swing trade because their size prohibits them from easily moving into and out of a position. Smaller traders, however, can profit from these short-term movements because their size allows them easier entry and exit from liquid positions. Swing trading is different from day trading or buy-and-hold investing. Those types of investors approach the markets differently, trade at different frequencies, and pay attention to different data sources. You must understand these differences so you don’t focus on aspects that are only relevant to long-term investors. The differences between swing trading and buy-and-hold investing If you’re a buy-and-hold investor in the mold of Warren Buffett, you care little for price swings. Over the long term, equity indexes have tended to rise across countries. Therefore, you prefer to buy quality businesses at discounts to their intrinsic value (also known as their true worth). You pore over financial statements and read the notes to the financial statements. You read through earnings call transcripts (the management presentations given after quarterly earnings results). Short-term price movements are merely opportunities to pick up securities (or exit them) at prices not reflective of their true value. In fact, buy-and-hold investors tend to have a portfolio turnover rate (the rate at which their entire portfolio is bought and sold in a year) below 25 percent — meaning they turn over their portfolio once very four years. Buy-and-hold investing is an admirable practice, and many investors should follow this approach, because it’s not as time-intensive as swing trading and not as difficult (in my opinion). But if you have the work ethic, discipline, and interest in swing trading, you can take advantage of its opportunities to achieve the following: Generate an income stream: Buy-and-hold investors are generally concerned with wealth preservation and growth. They don’t invest for current income because they sometimes have to wait a long time for an idea to prove correct. Swing trading, on the other hand, can lead to current income. Time your buys and sells and hold a basket of positions to diversify and manage risk: The majority of people aren’t interested in closely following their finances and are best served by investing in a basket of domestic and international mutual funds covering stocks, commodities, and other asset classes. Swing traders can hold a few securities across asset classes or sectors and generate higher profits than those who invest passively. Achieve lower drawdowns than buy-and-hold investing: Sometimes markets become overvalued. Just because a market is expensive doesn’t mean it will tank. Markets often go from being overvalued to even more overvalued. This inevitably sets the stage for a major market crash (think 2000 or 2008). During market crashes, buy-and-hold investors can experience drawdowns of 50 percent or more, meaning a decline in portfolio value from peak to trough. Swing traders, on the other hand, are only in the market when there is opportunity. If the trend is down, swing traders can sit on the sidelines with their cash in tact until sunny days return. The differences between swing trading and day trading Opposite the buy-and-hold investor on the trading continuum is the day trader. Day traders rarely hold positions overnight. Doing so exposes them to the risk of a gap up or down in a security’s price the following day that could wipe out a large part of their account. Instead, they monitor price movements on a minute-by-minute basis and time entries and exits that span hours. Day traders have the advantage of riding security price movements that can be quite volatile. This requires time-intensive devotion on their part. Near-term price movements can be driven by a major seller or buyer in the market and not by a company’s fundamentals. Hence, day traders concern themselves with investor psychology and news flow more than they do with fundamental data. They’re tracking the noise of the market — they want to know whether the noise is getting louder or quieter. But it’s not all cake and tea for day traders. They trade so often they rack up major commission charges, which makes it that much more difficult to beat the overall market. A $5,000 profit generated from hundreds of trades may net a day trader a significantly reduced amount after commissions and taxes are taken out. This doesn’t include additional costs the day trader must sustain to support his or her activities. Swing traders also face stiff commissions (versus the buy-and-hold investor), but nothing as severe as the day trader. Because price movements span several days to several weeks, a company’s fundamentals can come into play to a larger degree than they do for the day trader (day-to-day movements are due less to fundamentals and more to short-term supply and demand of shares). Also, the swing trader can generate higher potential profits on single trades because the holding period is longer than the day trader’s holding period.

Article / Updated 08-30-2019

When you know the maximum amount of capital you want to allocate to a single position — based on the percent of capital approach or the risk level approach — you’re ready to take a step back and see the forest for the trees. The risk of focusing on individual securities at the expense of your portfolio is a simultaneous breakdown of several positions. If you have 25 positions in your portfolio, for example, and the amount at risk for each position is 1 percent, it’s conceivable (and almost anything can happen in financial markets) that all 25 positions will go against you at the same time and cause a major loss of 25 percent of your portfolio. Don’t believe it can happen? Consider that U.S. equity markets dropped 22.6 percent on October 19, 1987 (during what had been a strong bull market). Few believed a move of that magnitude could happen in a single day. That loss actually exceeded any single-day loss experienced during the Great Depression. External factors beyond anyone’s control can impact markets day to day. And it’s possible for a company you own shares in to announce a lawsuit or loss of a key customer, which could send the shares tanking in a heartbeat. To combat this risk, monitor the risk not only at the individual stock level, but also at the total portfolio level. Manage risks: Limit all position losses to 7 percent The prudent approach to limit the losses from all your positions is to place a ceiling on the amount of capital you risk at any one time. Determine how much to risk on any single position — I recommend between 0.25 percent and 2 percent of total capital. The cumulative total of the amount at risk for each position is considered your total capital at risk. I recommend limiting your total capital at risk to 7 percent. Doing so means that the most you could lose in a single day if everything were to go wrong is 7 percent. Of course, you shouldn’t set stop losses so close to your entry prices that they’re triggered frequently; that may be a sign you aren’t giving your stock room to fluctuate. A 7 percent level should rarely (if ever) be triggered because it would require all position stop losses to be executed on the same day. The maximum amount you should risk in a single position, in my opinion, is 0.5 percent. This amount allows you to have at least 14 positions (0.5% × 14 = 7%). The larger the amount you risk on a single position, the fewer positions you can hold. And the fewer positions you hold, the higher the risk of your portfolio and the greater chance of a major account value swing that may be difficult to recover from. To help you understand how this 7 percent rule works, consider an example: Trader Bob has constructed a portfolio of seven different positions that’s worth $50,609. Figure 10-2 shows, from left to right, the symbol of each of his positions, the current stock price for each of his positions, his entry price, the number of shares he owns, his stop-loss level (exit level), and his total amount at risk based on the specified exit level. The total amount of capital that Trader Bob has at risk based on this portfolio is 5.25 percent, found by summing up the Amount at Risk column. So, Trader Bob can risk an additional 1.75 percent of his portfolio on new positions before he hits the 7 percent ceiling that I recommend. That 1.75 percent may be spread across five or more positions. If you enjoy finding Waldo, you may have noticed that the amount of risk listed for shares of AAPL, or Apple Inc., is 0.00 percent. What gives? As a position moves in your favor, you can adjust the stop-loss price higher or lower, depending on the direction you’re trading. In this case, shares of AAPL were purchased at $140.92 and promptly began rising. After a nice gain, Trader Bob decided to raise his stop-loss level to his entry price level. Doing so meant he could risk more capital in other positions he owns. The assumed worse outcome from his position in AAPL is to break even (barring the stock price gapping down). The amount at risk can never be a negative value, so don’t use negative risk amounts when you can raise your stop-loss order to a price that locks in a profit. If Trader Bob raises his stop loss to $150 in the future, his amount at risk isn’t –0.5 percent. Raising your stop-loss order ensures your portfolio doesn’t swing trade too aggressively and compensates for the inherent limits of stop-loss orders. After all, you may or may not get executed at your stop-loss price. So if a security gaps down below your stop-loss price, your stop-loss order will be executed at a much lower price than you anticipated. Diversify your allocations Another method of limiting losses on a portfolio level is diversification. No doubt you’ve heard the term thrown around on financial news networks. It seems every expert often recommends avoiding “putting your eggs in one basket.” Fortunately for you, this section gives you a bit more to go on than a farm analogy. Diversification is one of the shining gems mined from academia. In a nutshell, investing in more than one company, industry, country, or trading vehicle helps protect you if a problem befalls one or more of those holdings. The aim is to have a portfolio in which some securities’ gains offset other securities’ losses. The best scenario is simply a portfolio with all gainers, but some positions make money while others lose money. At its simplest level, diversification can be seen as a tool of avoiding the problems of a single company. For example, you may buy shares in General Motors and Ford so that, if Ford takes a tumble, your shares in General Motors can offset your losses. But what happens if a trade war brings down both General Motors and Ford? In that scenario, owning securities not in the auto business may be prudent. So, you pick up shares of Nike and Amazon. But when the United States goes into recessions, shares of all your U.S.-based companies are likely to fall. That means you may want to be investing in Asia or Europe as well. These examples give you an idea of the benefits of diversification. The simplest form of diversification is investing in several securities, but you also can diversify according to industry exposure, country, and asset class. I cover all three of these options in the following sections. By number of securities The most elementary way of diversifying your portfolio is simply to spread your assets across several securities. The more, the better — the thinking goes. But how many securities constitute a diversified portfolio? The benefits of diversification can be realized with 10 to 20 securities, but I should warn you: This number assumes the companies are in different industries and countries. Investing in 10 semiconductor manufacturers doesn’t expose a portfolio to businesses outside of a small niche of the market. Your trading plan should indicate a target number of positions you trade. The more positions you have, the less time you’ll have to devote to each single one and the more likely your returns will mirror the market. So, keep your number below 20. Following the position sizing guidelines largely takes care of this first point of diversification by number because the risk guidelines ensure that you have several positions. But if you’re going to brave the market without these guidelines, try to construct a portfolio of at least ten different positions and securities in different industries (see the following section for tips). By industry exposure According to William J. O’Neil, founder of Investor’s Business Daily, an industry group roughly determines 30 to 40 percent of a security’s return. So being exposed to only one or two industry groups is extremely risky because the returns of your securities will be very similar. Think about it in terms of the auto example from earlier in this chapter: Are the factors affecting General Motors and Ford all that different? Or United Airlines and Delta? Exxon Mobil and Chevron? Figure 10-3 is an outline of the major industry sectors (as defined by the Global Industry Classification Standard, or GICS). Fortunately, the software services you use should break down the industry or economic sector that your securities belong to. There’s nothing wrong with concentrating in a few sectors — say four or five. But beware of investing in only one or two sectors because you won’t benefit from the diversification benefits inherent in investing in different parts of the economy. Be sure to set a minimum number of industry groups that you trade in. I recommend identifying at least three different sectors and trading a minimum of five different industry groups, smaller classification groupings than sectors. For example, healthcare equipment, healthcare providers, and healthcare technology are all industry groups in the healthcare sector so investing across these three industries would not diversify your portfolio outside of the healthcare sector. By asset class and country Another way to diversify your portfolio is to invest in different asset classes and countries. The asset classes you trade decrease your overall portfolio risk, so if you’re using this approach, you should shoot to trade two to three different asset classes. Different countries exhibit different risk characteristics; I try to trade equities in at least two to three different countries. Three vehicles for achieving diversification by asset class and countries are exchange-traded funds (ETFs), American Depository Receipts (ADRs), and Real Estate Investment Trusts (REITs). Exchange-Traded Funds (ETFs) ETFs have exploded in growth over the last few years with assets topping $4 trillion. ETFs are funds that represent baskets of securities — such as a basket of stocks in the same industry, a basket of commodities (such as energy or agricultural commodities), or a basket of foreign equities (listed in Mexico, Brazil, China, or Turkey, among many others). Trading ETFs helps diversify your portfolio across several securities in one sector or country. For example, you may be right on a substantial move in oil stocks, but you may select the one oil company that’s having problems. Buying an energy ETF (such as the iShares US Energy ETF) allows you to profit from the movement of several energy stocks. Purchasing one ETF is like instant diversification across a style or sector of the market. However, for investors who are socially responsible and care about environment, social, and governance issues, keep in mind that an ETF doesn’t allow you to exclude companies that fail to meet specific socially responsible guidelines. Therefore, you’re best off investing in individual stocks that do meet your guidelines. Sometimes there’s a bull market in commodities whereas stock markets are lagging. So various asset classes can provide a boost of returns in addition to lower risk. Here are some of the main ETFs that offer you exposure to commodities: Precious metals: Gold can be traded via SPDR Gold Shares Gold (symbol: GLD in the United States); silver can be traded via iShares Silver Trust (symbol: SLV). If you’re interested in metals and mining, you can swing trade the SPDR S&P Metals & Mining ETF (symbol: XME). Energy: Your options for trading energy ETFs include Energy Select Sector SPDR (symbol: XLE). Or you can trade energy stocks that rise and fall with the price of oil. Energy exploration and production companies especially track changes in crude oil and natural gas prices. Agricultural commodities: Many ETFs give you exposure to agricultural commodities such as timber (symbol: WOOD) or fertilizers and agricultural chemicals (symbol: VEGI). I don’t recommend trading ETFs that track currencies because currencies aren’t a recommended investment (given that nearly all currencies are fiat, meaning they only hold value because the government says so; over time, currencies lose value because of inflation). American Depository Receipts (ADRs) ADRs allow you to take advantage of strength (or weakness) in a company based outside the United States without ever leaving home. Currently, the fastest growing markets are in China, India, and Africa. Mixing international securities into your portfolio offers greater diversification benefits than having only U.S. stocks because international markets may zig when the U.S. market zags. The more technical explanation of the benefit of ADRs is that foreign securities have lower correlation ratios to the U.S. market than domestic securities. Of course, the currency of those foreign markets may also improve (or hurt) your returns. Real Estate Investment Trusts (REITs) A REIT gives investors access to several properties — apartment complexes, office buildings, healthcare facilities, and even infrastructure, such as data centers where the cloud is stored or cellphone towers. REITs must distribute at least 90 percent of income to shareholders. Hence, they tend to have high dividend yields. Real estate can behave differently than other market segments because it tends to have higher dividend yields, lower beta, and is sensitive to unexpected changes in interest rates.

Article / Updated 08-30-2019

When swing trading, it's important to manage risks. When you know how to determine how risky a stock is, you can use that information to guide how you manage its risk in the context of your portfolio. Managing risk at the individual stock level means making sure that no single position destroys your portfolio. Managing risk at the portfolio level means preventing several small losses from destroying your portfolio. The way you manage risk at the individual stock level is through position sizing. And to set your position size, you have to know how much you’re willing to lose. That loss potential is directly related to the purpose of a stop-loss order, which ensures that should you be wrong — and you will be, many times — you can exit the position with (ideally) just a small loss. Figure out how much you’re willing to lose Most professional swing traders limit the amount of loss they’ll tolerate from a single position to 0.25 percent to 2 percent of total capital. Remember: Your loss will be affected by commissions, slippage, and market impact (the possibility of your trade moving the stock price up or down). Therefore, it may be best to stick to a yardstick of 0.75 percent of your capital, anticipating that these other costs will likely push your total loss to 1.25 percent or so of your capital. Before you even determine how much to invest in a security, you must first determine how much you’re willing to lose. If you agree with the 0.75 percent loss threshold that I recommend, simply take out a handy dandy calculator and compute: 0.75% × Your capital = Tolerable loss If your portfolio is $50,000, the most you should be willing to lose on a single position is $375. The amount you risk on a single position is different from the amount you buy or sell of that security. You may risk 1 percent or $1,000 (if your account value is $100,000) on a single position but end up buying $8,000 worth of that security. To achieve the risk of 1 percent, you must exit the position if the loss on the $8,000 reaches $1,000. Set your position size You can position size either by applying a percent of capital approach (a constant rate of capital, say 5 percent) or by allocating new positions by a risk level you identify. Regardless of which strategy you pursue, make sure you include some discussion in your trading plan on how you determine the risk level. By percent of capital Setting your position size based on a percent of capital is the simplest way to allocate capital to new positions. For example, if you have an account worth $50,000 and select a 3 percent level of capital to invest in each security, you allocate $1,500 to each trade. Many position traders (individuals with time horizons measured in months) invest an equal percentage of capital to each of their investments. As their capital base grows, they can invest more in each position. Conversely, as their capital base shrinks, they invest less in each position. Ultimately, invest in ways you feel most comfortable with. However, I strongly advise against varying the percent of capital invested in new securities instead of using a constant percent of capital approach, because setting different percentages can result in random performance. Having a higher conviction in one trade (and, thus, allocating a higher percentage to it) may interfere with the success of your strategy if you’re a poor predictor of your own success. Trading doesn’t have to be complicated to be fun and profitable. Adding complexity where none is needed can lead to sub-par returns. You won’t find a hard and fast rule when it comes to selecting a specific percentage level to use in setting position size. Choose a percentage level that’s too small (such as 0.5 percent), and hitting a home run won’t do much to boost your bottom line. But select a level that’s too large (such as 10 percent), and you could lose your shirt if the stock gaps down hard. Your stop-loss levels can only limit risk so much, and a security that gaps down will result in a loss larger than the 0.25 percent to 2 percent limit described earlier. Use the following rules to help you set your percent of capital position sizing level if you decide to use this method. Set a small percent of capital level (2 percent to 4 percent) if you trade securities that exhibit Illiquidity (remember, what’s liquid to you may not be liquid to a $1 billion investment fund; in other words, size matters) Low share prices ($10 or less is low) High betas (anything above 2.0) Small capitalization size (below $300 million) Set a large percent of capital level (4 percent to 8 percent) if you trade securities that exhibit Liquidity High share prices Low betas Mid and large capitalization sizes After setting the percent of capital you want to allocate to your trades, you have to set your stop-loss level. This part is easy given that you’ve already calculated your threshold of tolerable loss (refer to the earlier section “Figuring out how much you’re willing to lose”). Set your stop-loss level at the price that would cause the loss on your position to equal 0.75 percent of your total capital. Here’s an example of this process at work: Assuming an account value of $50,000 and a loss threshold level of 0.75 percent, the maximum loss you can tolerate on any one position is $375. You determine the time is right to buy shares in Dummies Corporation at $40 per share. You also decide to use a 6 percent of capital allocation approach to your swing trading. Where do you place your stop loss? Your stop loss should be set at a price that yields a loss of $375. Investing 6 percent of your assets in Dummies Corporation means you’ll buy 75 shares: 6 percent × $50,000 = $3,000 / $40 per share = 75 shares To arrive at your stop-loss level, divide your loss threshold by the number of shares you buy; then subtract the result from your purchase price to get your stop-loss level: $375 / 75 shares = $5 $40 – $5 = $35 stop-loss level By risk level Setting your position size using a percent of capital method may seem arbitrary. After all, isn’t that saying that you have no idea which trade will be profitable and which one won’t be? Technically, the answer to your astute question is yes; in effect, you’re saying that you have no idea which trade will be profitable. But then again, you wouldn’t be trading in the first place if you knew the trade wouldn’t be profitable. A smarter method of setting your position size is varying it according to your desired exit level. In the example that I set up in the previous section, you compute an exit level strictly based on the price that would produce a loss of 0.75 percent of your capital. Alternatively, you can determine a key level at which you want to exit and then determine a position size based on that level. This is how most professionals swing trade. An arbitrary price may have no meaning ($35 in the previous example), whereas a specific price level may signal the end or beginning of a trend. I use a chart to illustrate how a specific level can help you determine a position size. The following figure shows a chart of Alphabet Inc., commonly referred to as Google. Google’s shares have been consolidating and look ready to break out. Eager to make a quick buck, you decide to purchase shares. Before you calculate how large a position to take, assess the chart. This daily chart shows Google’s stock price from early April through mid-September. Google’s stock rose strongly from mid-May through late July — up 22 percent in two months. However, a poor earnings report sent Google’s stock sharply down (and serves as a reminder that trading around earnings reports can be hazardous). Pretend today is September 18, and you’ve decided Google is worth a swing trade. How much of your capital should you invest? Setting your position size based on a risk level requires you to determine a price that, if reached, indicates that the trade has gone sour. Obviously, if shares fall to $460, you have a hint that something isn’t right. But that’s far too late — you need a more immediate warning sign. Try using a previous swing low as a line in the sand for your stop-loss level. In this example, assume that the recent swing low highlighted in the chart is the level that, if reached, indicates that you’re wrong about the trade. That level is $505. Google’s stock is trading at $545, and you’re willing to risk 0.75 percent of your capital on each trade. (Remember: 0.75 percent represents the loss you’re willing to tolerate from a position, not the maximum amount you’re willing to allocate to a single position.) To calculate how many shares of Google to buy, use this formula and plug in your numbers: Amount of capital at risk / (Entry price – Stop-loss level) $375 (or 0.75% of $50,000) / ($545 – $505) = 9.375 shares, or 9 shares Thus, setting your position size based on your risk level means purchasing 9 shares of Google. (Round down when you have a fraction. Rounding up may mean adding more risk, whereas rounding down always keeps you below your specified loss threshold.) This example brings to light one weakness of this approach: The closer the exit price is to your entry price, the larger the implied position. In fact, if your exit price is $1 or less than your entry price, the preceding formula may tell you to invest more than your total capital in one stock, which makes no sense! The solution to this weakness is to put a ceiling on the amount you invest in any security. Colin Nicholson, a prolific swing trader from Australia, places a 6 percent ceiling on his trades. In the example, if you purchase 9 shares of Google at $545, you’re investing 9.81 percent of your $50,000 capital in one stock. Although technically only 0.75 percent of your capital is at risk (if you place your stop loss), there’s always a chance that the stock will gap down and cause your loss to be much greater than your stop-loss order. Stop-loss orders don’t guarantee an exit at the price specified because there’s always the chance a security may gap lower.