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Successful swing traders start each market day with a thoughtful analysis of current conditionsCONVERGENCE-DIVERGENCE Successful trade execution relies upon correct interpretation of the convergence-divergence (C-D) axis. This powerful concept defines relationships between price and all other aspects of the charting landscape. Indicators that trend in a different direction than price signal divergence. They converge when their movement corresponds with price direction. Divergent conditions mark negative feedback, while convergence aligns with positive feedback. One market can also converge or diverge with another. When S&P 500 goes up and Nasdaq 100 goes down, the two indices diverge. Bonds and index futures converge when they both rise. 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. Identify other conditions that support or conflict with current price development before making the trade. Determine how seasonality or time-of-day bias affects the odds for the predicted move. Consider the limitations of the indicator or landscape feature that exhibits the divergence. Oscillators in trending markets and trend-following indicators in flat markets both trigger many false signals. When in doubt, step to the sidelines and wait for a better opportunity. The most profitable trades will exhibit major convergence between many chart elements. READING MARKET SENTIMENT Successful swing traders start each market day with a thoughtful analysis of current conditions. Identify larger cycles, external influences, and important news that will likely drive price action. Then look at the most promising setups and decide whether they properly align with those complex forces. Evaluate any special risk associated with trading that day and decide how to alter execution strategy to adjust to the new environment. Should position size be increased or decreased? Should the first hour be avoided or aggressively traded? Are conditions ripe for a major rally, selloff, or reversal? Review current sentiment, important numbers, and technical indicators. Define what types of unexpected factors will tighten or relax current trade management tactics. Write down those parameters to avoid getting fooled, if required. Then execute according to the predetermined boundaries. Watch how the first hour action alters or adjusts this initial analysis. Then shift the active strategy to accommodate real reversals, breakouts, or breakdowns as they exert their influence. But beware of costly trend relativity errors. Make certain that important market shifts occur within the time frame of interest before adjusting the trading plan to accommodate them. AVOIDING THE MOMENTUM TRAP 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. Markets tend to correct for many months at a time. But most participants focus on relatively brief periods of strong upside momentum where they hope to pocket big gains. Unfortunately these exciting times also awaken greed and weaken risk management. Participants violate personal rules, chase dangerous positions, and develop an unhealthy sense of invulnerability. They also forget that the momo environment will disappear quickly and without warning. Strategies that work well in hot markets destroy trading accounts during cool ones. Most players carry a long-side momentum bias into topping markets and corrections. This triggers inappropriate positions, leads to missed opportunities, and empties the same pockets that filled so easily during parabolic rallies. Avoid this common trap as experience grows. 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. Combine market sentiment and Pattern Cycles to locate the best opportunities of the moment. Broad forces align well with different setups on individual stocks. First gauge current conditions and then decide what types of trades will work best in that environment. Make certain that strategies correspond to the same time frame as the analysis. When major indices converge, trade the same phase as their current Pattern Cycle whenever possible. When they don’t, choose positions that support general sentiment and current risk. Use S/R barriers on both stocks and broader indices to time profitable exits. 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. All sincere efforts will be greatly rewarded. The easiest trades always come early in a trend before the crowd notices them. Profit from momentum markets, but don’t fall in love with them. Increased risk always follows increased reward. Work to broaden execution skills and learn to trade anything that offers a good opportunity. 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. THE BIG PICTURE Swing traders must digest a vast amount of market information to reach simple conclusions about opportunity and risk. 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. Are they rangebound or trending? Are oscillators rising or falling? Do they converge or diverge? Each index has characteristics that affect and distort daily results. Take the time to learn their construction and how individual stock movement can generate lopsided information. For example, a Microsoft rally or selloff on certain days in 1999 accounted for most price change in both the Dow 30 and Nasdaq 100. Follow those indices and measurements that impact daily decision-making. Nasdaq Composite, Nasdaq 100, S&P 500, and the Dow Industrials provide most of the data required to participate in the American markets. Swing traders can isolate many subsector rallies and selloffs through these major influences. Also follow the bond futures or bond yield and add smaller markets that generate special interest. But discard information quickly if it doesn’t improve the bottom line. Many equity traders now keep active futures data on their real-time screens. The decline of Chicago Merchantile Exchange (CME) fees and birth of the S&P E-Mini index futures contract allow retail participants to view derivative markets that were hidden to the public just a few years ago. Start to examine futures by replacing S&P 500 Index quotes with the popular E-Mini. Then view the interplay between that market and equities. This daily tug and pull explains much of the short-term price oscillation that appears as noise to most observers. With a little practice, swing traders can build strategies that carefully time execution to these fluctuations. The S&P futures crowd has a higher percentage of professionals than equities. Swing traders can see their participation on the intraday charts. Major fades follow almost every wide bar movement. This gives an odd porcupine appearance to the flow of price action. Use this phenomenon as a noise filter for execution of equity positions. Real breakouts and breakdowns will thrust past these fade points while false moves terminate at them. Pay attention and learn to stand aside when others get caught in small intraday price ripples that bleed trading accounts. |
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