SWING TRADING
Table of Contents
Introduction ................................................................. 1
About This Book ..............................................................................................2
Conventions Used in This Book .....................................................................3
Foolish Assumptions .......................................................................................3
How This Book Is Organized ..........................................................................4
Part I: Getting into the Swing of Things ..............................................4
Part II: Determining Your Entry and Exit Points:
Technical Analysis .............................................................................4
Part III: Digging Deeper into the Market: Fundamental Analysis .....4
Part IV: Developing and Implementing Your Trading Plan ...............5
Part V: The Part of Tens ........................................................................5
Icons Used in This Book .................................................................................5
Where to Go from Here ...................................................................................6
Part I: Getting into the Swing of Things ......................... 7
Chapter 1: Swing Trading from A to Z. . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
What Is Swing Trading? .................................................................................10
The differences between swing trading and
buy-and-hold investing ....................................................................11
The differences between swing trading and day trading ...............12
What Swing Trading Is to You: Determining Your Time Commitment ...13
Swing trading as your primary source of income ............................13
Swing trading to supplement income or improve investment
returns ...............................................................................................14
Swing trading just for fun ....................................................................15
Sneaking a Peek at the Swing Trader’s Strategic Plan ..............................15
The “what”: Determining which securities you’ll trade ..................16
The “where”: Deciding where you’ll trade ........................................18
The “when” and the “how”: Choosing your trading
style and strategy .............................................................................19
Building Your Swing Trading Prowess ........................................................24
Chapter 2: Understanding the Swing Trader’s
Two Main Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25
Strategy and Style: The Swing Trader’s Bio ...............................................25
Two forms of analysis, head to head.................................................26
Scope approach: Top down or bottom up? ......................................27
Styles of trading: Discretionary versus mechanical ........................28
xii Swing Trading For Dummies
Wrapping Your Mind around Technical Theory .......................................29
Understanding how and why technical analysis works ..................29
Sizing up the technical advantages and disadvantages ..................31
The two main aspects of technical analysis .....................................33
Appreciating the Value of the Big Picture: Fundamental Theory ............34
Understanding how and why fundamental analysis works ............35
Surveying the fundamental advantages and disadvantages ..........36
Looking at catalysts and the great growth/value divide ................38
Chapter 3: Getting Started with Administrative Tasks . . . . . . . . . . . . .41
Hooking Up with a Broker ............................................................................42
Choosing a broker................................................................................42
Opening an account .............................................................................45
Selecting Service Providers ..........................................................................46
Providers to do business with ...........................................................46
Providers to avoid ...............................................................................50
Starting a Trading Journal ............................................................................52
Creating a Winning Mindset .........................................................................56
Part II: Determining Your Entry and
Exit Points: Technical Analysis .................................... 57
Chapter 4: Charting the Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59
Nailing Down the Concepts: The Roles of Price and
Volume in Charting ....................................................................................60
Having Fun with Pictures: The Four Main Chart Types ............................61
Charts in Action: A Pictorial View of the Security Cycle of Life ..............64
The waiting game: Accumulation .......................................................64
The big bang: Expansion .....................................................................66
The aftermath: Distribution ................................................................67
The downfall: Contraction ..................................................................69
Assessing Trading-Crowd Psychology: Popular
Patterns for All Chart Types .....................................................................70
The Darvas box: Accumulation in action ..........................................71
Head and shoulders: The top-off .......................................................73
The cup and handle: Your signal to stick around for coffee ..........74
Triangles: A fiscal tug of war ..............................................................76
Gaps: Your swing trading crystal ball ...............................................77
Letting Special Candlestick Patterns Reveal Trend Changes ..................80
Hammer time! .......................................................................................80
The hanging man (Morbid, I know) ...................................................82
Double vision: Bullish and bearish engulfing patterns ...................82
The triple threat: Morning and evening stars ..................................83
Table of Contents xiii
Measuring the Strength of Trends with Trendlines ..................................85
Uptrend lines: Support for the stubborn bulls.................................86
Downtrend lines: Falling resistance ..................................................87
Horizontal lines: Working to both support and resist ....................88
Chapter 5: Asking Technical Indicators for Directions. . . . . . . . . . . . .89
All You Need to Know about Analyzing Indicators Before You Start .....90
You must apply the right type of indicator ......................................90
Not all price swings are meaningful ..................................................90
Prices don’t reflect volume, so you need to account for it ............92
An indicator’s accuracy isn’t a measure of its value .......................92
Two to three indicators are enough ..................................................93
Inputs should always fit your time horizon ......................................94
Divergences are the strongest signals in technical analysis ..........95
Determining Whether a Security Is Trending ............................................95
Recognizing Major Trending Indicators .....................................................97
The compass of indicators: Directional Movement Index (DMI) ...98
A mean, lean revelation machine: Moving averages .....................100
A meeting of the means: MACD ........................................................105
Spotting Major Non-Trending Indicators ..................................................107
Stochastics: A study of change over time .......................................108
Relative Strength Index (RSI): A comparison
of apples and oranges ....................................................................111
Combining Technical Indicators with Chart Patterns ............................114
Using Technical Indicators to Determine Net Long or Net
Short Positioning......................................................................................115
Chapter 6: Analyzing Charts to Trade Trends, Ranges, or Both. . . . .117
Trading Trends versus Trading Ranges: A Quick Rundown ..................118
Trading on Trends .......................................................................................120
Finding a strong trend .......................................................................120
Knowing when to enter a trend ........................................................122
Managing your risk by setting your exit level ................................124
Trading Ranges: Perhaps Stasis Is Bliss? ..................................................125
Finding a security in a strong trading range ..................................125
Entering on a range and setting your exit level .............................127
Comparing Markets to One Another: Intermarket Analysis ...................128
Passing the buck: The U.S. dollar ....................................................128
Tracking commodities.......................................................................130
Watching how bond price and stock price
movements correlate .....................................................................133
Putting Securities in a Market Head-to-Head:
Relative Strength Analysis ......................................................................134
Treating the world as your oyster: The global scope ...................135
Holding industry groups to the market standard ..........................137
xiv Swing Trading For Dummies
Part III: Digging Deeper into the
Market: Fundamental Analysis .................................. 141
Chapter 7: Understanding a Company, Inside and Out . . . . . . . . . . . .143
Getting Your Hands on a Company’s Financial Statements ...................144
What to look for .................................................................................144
When to look ......................................................................................145
Where to look .....................................................................................146
Assessing a Company’s Financial Statements .........................................146
Balance sheet .....................................................................................147
Income statement ..............................................................................151
Cash flow statement ..........................................................................153
Not Just Numbers: Qualitative Data ..........................................................156
Valuing a Company Based on Data You’ve Gathered .............................158
Understanding the two main methods of valuation ......................158
Implementing the swing trader’s preferred model ........................159
Chapter 8: Finding Companies Based on Their Fundamentals . . . . .163
Seeing the Forest for the Trees: The Top-Down Approach ....................163
Sizing up the market ..........................................................................164
Assessing industry potential ............................................................170
Starting from the Grassroots Level: The Bottom-Up Approach ............172
Using screens to filter information ..................................................173
Assessing your screening results ....................................................179
Deciding Which Approach to Use .............................................................179
Chapter 9: Six Tried-and-True Steps
for Analyzing a Company’s Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
The Six Step Dance: Analyzing a Company ..............................................181
Taking a Company’s Industry into Account .............................................183
Scoping out markets you’re familiar with .......................................184
Identifying what type of sector a company is in ............................184
Determining a Company’s Financial Stability ..........................................187
Current ratio .......................................................................................188
Debt to shareholders’ equity ratio ..................................................188
Interest coverage ratio ......................................................................189
Looking Back at Historical Earnings and Sales Growth ..........................190
Understanding Earnings and Sales Expectations ....................................192
Checking Out the Competition ..................................................................194
Valuing a Company’s Shares ......................................................................197
Gauging shares’ relative cheapness or expensiveness .................197
Figuring out whether the comparative share-price
difference is justified .....................................................................198
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Part IV: Developing and Implementing
Your Trading Plan ..................................................... 201
Chapter 10: Strengthening Your Defense: Managing Risk . . . . . . . . .203
Risk Measurement and Management in a Nutshell .................................205
First Things First: Measuring the Riskiness of Stocks
before You Buy .........................................................................................205
Assessing the beta: One security compared to the market .........206
Looking at liquidity: Trade frequency .............................................207
Sizing up the company: The smaller, the riskier ...........................208
Avoiding low-priced shares: As simple as it sounds .....................209
Limiting Losses at the Individual Stock Level ..........................................209
Figuring out how much you’re willing to lose ................................210
Setting your position size .................................................................211
Building a Portfolio with Minimal Risk .....................................................215
Limit all position losses to 7 percent ..............................................215
Diversify your allocations .................................................................217
Combine long and short positions ..................................................220
Planning Your Exit Strategies .....................................................................221
Exiting for profitable trades .............................................................221
Exiting based on the passage of time ..............................................225
Exiting based on a stop loss level ....................................................225
Chapter 11: Fine-Tuning Your Entries and Exits . . . . . . . . . . . . . . . . . .231
Understanding Market Mechanics ............................................................231
Surveying the Major Order Types .............................................................233
Living life in the fast lane: Market orders .......................................233
Knowing your boundaries: Limit orders .........................................234
Calling a halt: Stop orders ................................................................234
Mixing the best of both worlds: Stop limit orders .........................234
Placing Orders as a Part-Time Swing Trader ...........................................236
Entering the fray ................................................................................236
Exiting to cut your losses (or make a profit) .................................237
Placing Orders if Swing Trading’s Your Full-Time Gig ............................237
Considering the best order types for you ......................................238
Taking advantage of intraday charting to time
your entries and exits ....................................................................238
Investigating who’s behind the bidding: Nasdaq
Level II quotes .................................................................................241
Chapter 12: Walking through a Trade, Swing-Style . . . . . . . . . . . . . .247
Step 1: Sizing Up the Market .......................................................................247
Looking for short-term trends on the daily chart ..........................248
Analyzing the weekly chart for longer-term trends .......................249
xvi Swing Trading For Dummies
Step 2: Identifying the Top Industry Groups ............................................250
Step 3: Selecting Promising Candidates ....................................................251
Screening securities ..........................................................................252
Ranking the filtered securities and assessing chart patterns ......252
Step 4: Determining Position Size ..............................................................255
Setting your stop loss level ..............................................................256
Limiting your losses to a certain percentage .................................257
Step 5: Executing Your Order .....................................................................258
Step 6: Recording Your Trade ....................................................................259
Step 7: Monitoring Your Shares’ Motion and Exiting
When the Time is Right ...........................................................................259
Step 8: Improving Your Swing Trading Skills ...........................................261
Chapter 13: Evaluating Your Performance. . . . . . . . . . . . . . . . . . . . . . .263
No Additions, No Withdrawals? No Problem! ..........................................263
Comparing Returns over Different Time Periods:
Annualizing Returns ................................................................................264
Accounting for Deposits and Withdrawals:
The Time-Weighted Return Method ......................................................266
Breaking the time period into chunks .............................................268
Calculating the return for each time period ...................................270
Chain-linking time period returns to calculate a total return ......271
Comparing Your Returns to an Appropriate Benchmark .......................272
Evaluating Your Trading Plan ....................................................................276
Part V: The Part of Tens ............................................ 277
Chapter 14: Ten Simple Rules for Swing Trading. . . . . . . . . . . . . . . . .279
Trade Your Plan ...........................................................................................279
Follow the Lead of Industry Groups as Well as the Overall Market ......281
Don’t Let Emotions Control Your Trading! ..............................................282
Diversify! .......................................................................................................283
Set Your Risk Level ......................................................................................283
Set a Profit Target or Technical Exit .........................................................284
Use Limit Orders ..........................................................................................284
Use Stop Loss Orders ..................................................................................285
Keep a Trading Journal ...............................................................................286
Have Fun! ......................................................................................................287
Chapter 15: Ten Deadly Sins of Swing Trading . . . . . . . . . . . . . . . . . .289
Starting with Too Little Capital ..................................................................289
Gambling on Earnings Dates ......................................................................291
Speculating on Penny Stocks .....................................................................291
Table of Contents xvii
Changing Your Trading Destination Midflight .........................................292
Doubling Down .............................................................................................293
Swing Trading Option Securities ...............................................................294
Thinking You’re Hot Stuff ...........................................................................295
Concentrating on a Single Sector ..............................................................296
Overtrading ..................................................................................................296
Violating Your Trading Plan .......................................................................297
Appendix: Resources ................................................. 299
Sourcing and Charting Your Trading Ideas ..............................................299
Trading ideas: MagicFormulaInvesting.com ..................................299
Trading software: High Growth Stock Investor ................................300
Financial newspaper with stock ideas:
Investor’s Business Daily ................................................................301
Charting software: TradeStation .......................................................302
Doing Your Market Research .....................................................................303
PIMCO’s Bill Gross commentary ......................................................303
Barron’s weekly financial newspaper ..............................................304
Keeping Tabs on Your Portfolio and the Latest Market News ..............305
Yahoo! Finance portfolio tool ...........................................................305
Yahoo! Economic Calendar...............................................................305
Fine-Tuning Your Trading Techniques .....................................................306
Technical Analysis of Stocks & Commodities magazine .................307
The Black Swan: The Impact of the Highly Improbable ..................307
Index ....................................................................... 309