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- Swing Trading: Rules and Philosophy (http://www.trade2win.com/articles/740-swingtrading-rules-philosophy)
Swing Trading: Rules and Philosophy
30 Jun, 2005
by Linda Bradford Raschke
My personal trading style is based on a method described in the 1950’s by a veteran floor trader named George Douglass Taylor. The
“Taylor Trading Technique” is a short-term method for trading daily price movements that relies entirely on odds and percentages. It is
a method as opposed to a system. Very few people can blindly follow a system, though many find it easier to be discretionary in a
systematic way.
Because this short-term swing technique generates frequent trades, it is important to know the correct plays, when to lock in profits,
and when to seek the true trend. Taking a loss is merely playing for better position. One trades strictly for probable future results, not
for what the market might do.
To know the correct play is to know whether to buy or sell first, to exit or hold. Trades are based on objective points, which are simply
the previous day's highs and lows. Movement between these two points determines the true trend.
When swing trading, adjust your expectations. The more conservative your expectations, the happier you will be and, ironically, the
more money you will probably make. Entries are actually the easy part of the method. What is more difficult is having the confidence
in your ability to get out of bad situations and bad trades early, and knowing when to use tighter stops for trading swings and wider
stops when trading trends.
The Taylor method teaches you to anticipate. Never react! Know what you are going to do before the market opens. Always have a
plan, but be flexible. See your stop (support or resistance) before initiating a trade. Again, knowing how to trade out of trouble
situations and how to get off the hook with the smallest possible loss is part of the skill.
Never trade in narrow, dead markets; the swings are too small. And never chase a market. Rather than worry that you've missed a
move, consider yourself fortunate that oscillations and volatility have come back into the market.
Basic Rules for Swing Traders
Because of the short-term nature of this technique, swing traders must adhere to some very basic rules, including:
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If the trade moves in your favor, carry it home overnight. The odds favor follow-through. Expect to exit the next day near
the objective point (explained later). An overnight gap presents an excellent opportunity to take profits. The exception is
when the market offers you windfall profits; take these to the bank on the close. Do not get cute.
Concentrating on only one entry or one exit per day relieves some of the mental pressure.
If your entry is correct, the market should move in your favor almost immediately. It may come back to test your entry point
a little, but that's OK.
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Do not carry a losing position overnight. Exit and play for better position the next day.
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Use tight stops when swing trading and wider stops when trading trends.
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A strong close usually indicates a strong opening the following day.
If the market doesn't perform as expected, exit on the first reaction.
If you are long and the market closes flat, indicating a lower opening the following day, scratch or exit the trade. Play for
better position the next day. It is always OK to scratch a trade!
The goal always is to minimize risk and create “freebies,” i.e, trades that move in your favor quickly, where the stop can be
moved to break even.
Training yourself how to think and act under pressure is a major part of the battle. Therefore, when in doubt, get out! You
have lost your road map and your game plan. It’s an old cliché, but when dealing with real money, it’s one cliché you want
to respect.
Place your orders at the market. Do not get cute trying to price your trades with limit orders.
When a trade isn't working, exit on the first reaction.

Always anticipate. Do not get caught up in reacting to market moves.
“Trading the Swing”
What is the basis of the Taylor Technique, and how does one begin to anticipate an entry? Here are some basic guidelines.
The Count
Start searching for a buying day two days after the market makes a swing high. Conversely, search for a shorting day two days after a
swing low. Ideally, the market will move in complete five-day cycles. In stronger trends, the market will move four days in the primary
direction and only 1 in reaction, allowing you to seek entry 1 day earlier.
“Check Mark” on the Test
Entries are sought opposite, or contrary to, the previous day's close. For example, if looking to buy, one first wants the market to “test”
the previous day's low, preferably early in the day, and then form a trading pattern that looks like a “check mark” or a small “W” (see
examples).
This pattern sets up and establishes a "double stop point" or strong support. If entering a market with only a “single stop point” – e.g.,
support formed by the current day’s low only without a test, then exit on the same day. These trades are usually against the trend.
Close vs. Open
The close should indicate the following day's opening direction. When a market opens opposite what is expected or indicated by the
trend, you can first look to “fade” it (i.e., trade in the opposite direction) but take profits quickly. Then look to reverse!
Support & Resistance
The key question when swing trading with the Taylor method is: is today's support (or resistance) higher or lower than yesterday’s
corresponding support (or resistance)?
Swing Measurements
Where is the current market relative to the last swing high or low? Always look for swings – both up and down – of equal length, and
for retracements of equal percentage.
Additional Considerations
No matter what time frame you trade – intraday, daily, weekly, etc. – always look for indications of supply near potential selling points,
and signs of demand near potential buying points. Supply and demand shows itself following a successful test in the form of rapid
directional movement in the direction of the trade. Conversely, a lack of supply or demand at a previous low or high, results in a
penetration. Valid penetrations are accompanied by an increase in volume and greater trading activity.
On average, expect trends (both up and down) to last between 2 to 3 weeks. The following conditions are fairly reliable indicators for
the start of a trend. Personally, I skip the first buy or sell swing when one of these indications occurs, because the ensuing move is
often quite strong.
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The narrowest daily high to low range in the last 7 days
3 consecutive days with small range
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The point of a “wedge” pattern
A breakaway gap from a chart pattern such as triangle.
A rising ADX (14-period) above 32
Practice
Because a certain amount of confidence is required to trade any technique consistently, paper trading helps cultivate the faith
necessary to recognize and trade the Taylor pattern. Although the temptation to try too many different styles and patterns always
exists, one must strive ultimately to trade in just one consistent manner.
Method Characteristics
Certain points about trading short-term swing trading deserve note. Understanding the nature of the method and its return
characteristics will help you recognize and deal with the psychological aspects of trading this method.
When consistently following a short-term system, you should expect a high win to loss ratio. Though the objectives with this style
trading are conservative, you will almost always incur “positive slippage.” For example, buying into a test of the previous day’s low, or
selling into a test of the previous day’s high gives you an edge in the slippage department that trend followers do not often enjoy.
In all systems, winners are skewed. Though swing trading is designed to make small but steady profits, 3-4 really big trades may
actually make your month. Thus it is vitally important to “lock in” your winning trades. Simply put, do not give back open profits when
short-term trading. You may be surprised at just how large some winners are from catching the swings just right.
Decision-Making
It is important to remember that every time you make a trade, you are making a decision. The more decisions you make, the more you
increase your self-confidence.
You grow with each decision, yet each decision has a price. For example, you must discard a choice, and you must commit.
Remember that conditions are never perfect. You must allow yourself to fail. Allow for human limitations and wrong choices. Reserve
compassion for yourself and your limitations.
There is almost too much instantaneous information available to traders today. It is really OK to use intuition and to respect the voice
inside your head, “Does the trade feel right?” If not, get out. Learn to respect your intuition.
Golden Rules
Finally, I want to leave you with what I believe are two Golden Rules, applicable to all traders but, of essential importance to short-term
swing traders:
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Never, ever, average a loss. Exit if you think you are wrong. Re-enter the trade when you believe you are right or the picture
become clear again.
Never listen to anyone else's opinion. Only you know when your trade isn't working.
Read the Market Using Price and Volume
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Dr Gary Dayton
04 Mar, 2010
in Technical Analysis
Many traders do not use volume in their market analysis and trading. They rely on price bar
patterns and technical indicators. Price alone can be misleading and technical indicators
frequently signal miss-fires. Understanding the interaction of price and volume can help put
the trader on the right side of the market regardless of the trading method used. Here is a
recent example of how the S&P e-mini market unfolded. Reading the interaction of price and
volume led to both intraday and swing trades.
Background: 60-Minute Chart
The S&P e-mini market had reacted into early February from its highs in January 2010. The
reaction was well-defined on the hourly chart (Chart 1) by the trend lines AA and BB, which
together formed a channel. Line AA was drawn off the obvious rally peaks and Line BB from
the low points.
At point 3 on Chart 1 (February 5th), the market became potentially oversold by its position
in the trend channel. When a trend has respected its trend lines as here, a penetration of the
lower trend line typically indicates an oversold market. Subsequent market action proved this
correct, and the market rallied vigorously.
How to Read Intraday Volume
On a typical market day in the S&P e-minis, volume is heaviest in the first 90 minutes of the
day and again in the last 60-90 minutes. Volume is usually light in between these periods,
with the lightest volume occurring during the noon hour period (New York Time). A typical
day in volume will often look U-shaped.
It was notable, therefore, when volume expanded on bars 3, 4 and 5. It signified that market
behavior had changed. Bars 4 and 5 reflected a significant rally on sustained, high volume something we had not seen before in this downdraft. In fact, Bar 5 is the largest up bar on the
largest volume since the downtrend had begun. This is usually significant and a useful
"market tell" that no indicator will register. In this case, the market rejected lower, oversold
prices and then rallies strongly - bullish behavior.
The next day (February 8th), the market falls back down on Bar 6 reaching a low of 1053. At
this point, it is unclear whether the market will fall lower the next day. Although price did not
fall hard after breaking the early morning low on this day, sellers did close the day on its lows
and volume expanded on Bar 6, indicating supply remained present.
Daily Highs & Lows
On February 9th, we have a small gap opening and a brief rally into yesterday’s high. In
trading the S&Ps, yesterday’s high and low are often key reference levels of support or
resistance. Take a good look at any daily chart of the S&P e-minis and you will see that there
is a lot of trading around the previous day’s high or low. Good day trades often set up around
these levels. After testing yesterday’s high, the market fell back about 10 points towards
yesterday’s low.
That low did not get breached, however. Buyers came in strongly and drove the market back
up to a new high on the day. This is Bar 7. Note the strong close, wide range, and the high
volume. Demand came into the market.
Accumulation
The next day (February 10th), the market drops lower at Bar 8, but once again, we see buying
come in at about the same level as on Bar 6 and Bar 7. The low at Bar 6 was 1053.00. The
low at Bar 7 was 1058.00. Bar 8 dipped down to a low of 1056.25 before buying came in.
Note that the close of this bar is in the middle, and then rallies. The volume is high.
The next morning (February 12th) opens and the market drops back into the same zone where
buyers were present at Bars 6, 7, and 8. Here on Bar 9, volume was comparatively light on
the dip into the buying zone. The market then rallies strongly and breaks the Trend Line AA
for the first time.
We can now take a closer look at the market from the perspective of price and volume and
begin to make some useful conclusions. We can go back in time a bit and see that high
volume came in on Bar 1 and Bar 2 at the same level of buying that we have seen since the
lows at Bar 3 had been put in. I have highlighted the level with a green line. It is likely that
buying - partially under the cover of the drive down to the February 5th lows - had been
occurring as early as February 4th and continued through the following week.
We can also see that the lows had been lifting along the red dashed Line CC. This indicates
that buyers were becoming more eager and more aggressive in their buying (and supply was
progressively decreasing) as the trading range progressed. On the last day of the hourly chart,
the market gapped back below Line AA, but held the rising Line CC and rallied back out of
the down trend channel, closing on its high and decisively breaking the back of the
downtrend.
Value of Price & Volume - Swing Trade
It is worthwhile to note that many traders writing blogs and making YouTube commentaries
were calling for "a new leg down" as price was approaching their downtrend lines. Those
traders who can read price and volume action would at least be skeptical of these calls. In
developing these skills, traders place themselves in a position of being able to read the market
by its own action, without having to rely on others or on frequently bewildering indicators.
The implications for a swing trader are obvious. There was evidence of sufficient buying for
a good swing trade. This was accumulation in action. Once traders with enough wherewithal
have stepped into the market and repeatedly bought over several days like this, the odds favor
that "a new leg up" is in the immediate future.
A Day Trade
Day traders can also take advantage of this situation. On February 12th (Friday), the market
pushed above the downtrend channel and closed the day on its high (1079.25). After the long,
holiday weekend (President’s Day in the US), the market gapped open, but quickly fell off.
On the 5-minute chart, we see buyers step in as the market comes down to and tests the
previous day’s high. On bar 1, there is an increase in volume and a strong close on the 5minute bar. Traders who had been assessing the market the previous week would be primed
to step in and buy at this point. On Bar 2, the market offered a second opportunity for a long
position. Here the volume receded as price came back down to yesterday’s high signifying
that selling was non-existent. This touched off a trend day to the upside where the market
rallied throughout the day and closed on its high. It also ignited a multiday rally that
rewarded the swing trader.
Learning to read the market by its own action is a skill. Like any skill, it takes dedicated
practice to develop.
Capturing Trend Days
24 Dec, 2004
by Linda Bradford Raschke
Capturing Trend Days
Trend days occur when there is an expansion in the daily trading range and the open and close are near opposite extremes. The first
half-hour of trading often comprises less than 10% of the day's total range; there is usually very little intraday price retracement.
Typically, price action picks up momentum going into the last hour -- and the trend accelerates.
Classic Trend Day - A large opening gap created a vacuum on the buy side. The market opened at one extreme and closed on the
other. Note how it made higher highs and higher lows all day. Also, volatility increased in the latter part of the day--another
characteristic of trend days.
A trend day can occur in either the same or the opposite direction to the prevailing trend on daily charts. The critical point is that the
increased spread between the high and low of the daily range offers a trading opportunity from which large profits can be made in a
short time.
Traders must understand the characteristics of a trend day, even if interested only in intraday scalping. A trader anticipating a trend
day should change strategies, from trading off support/resistance and looking at overbought/oversold indicators to using a breakout
methodology and being flexible enough to buy strength or sell weakness. A trader caught off guard will often experience his largest
losses on a trend day as he tries to sell strength or buy weakness prematurely. Because there are few intraday retracements, small
losses can easily get out of hand. The worst catastrophes come from trying to average losing trades on trend days.
Fortunately, it is possible to identify specific conditions that tend to precede a trend day. Because this can easily be done at night when
the markets are closed, a trader can adjust his game plan for the next day and be prepared to place resting buy or sell stops at
appropriate levels.
The Principle of Range Contraction/Expansion
caption: Trend Day Down
Several types of conditions lead to trend days, but most involve some type of contraction in volatility or daily range. In general, price
expansion tends to follow periods of price contraction, the phenomenon being cyclical. The market alternates between periods of rest
or consolidation and periods of movement, or markup/markdown. Volatility is actually more cyclical than is price.
When a market consolidates, buyers and sellers reach an equilibrium price level -- and the trading range tends to narrow. When new
information enters the marketplace, the market moves away from this equilibrium point and tries to find a new price, or "value" area.
Either longs or shorts will be "trapped" on the wrong side and eventually forced to cover, aggravating the existing supply/demand
imbalance.
In turn, the increase in price momentum attracts new market participants, and pretty soon a vicious cycle is created. Local pit traders,
recognizing the one-way order flow, scramble to cover contracts. Instead of price reacting back as in normally trading markets,
"positive feedback" is created -- a condition in which and no one can predict how far the price will go. The market tends to gain
momentum rather than to check back and forth.
Tick Readings for Short-term day trading - Volatility conditions are important to quantify even if you are a short term day trader. In a
normal consolidation market, overbought/oversold type indicators, such as intraday tick readings, can work well for S&P scalps.
We can tell when the market is approaching the end of contraction or congestion because the average daily ranges narrow. We know a
potential breakout is at hand. However, it is difficult to predict the direction of the breakout because buyers and sellers appear to be in
perfect balance. All we can do is prepare for increased volatility or range expansion!
Most breakout trading strategies let the market tip its hand as to which way it wants to go before entering. This technique sacrifices
initial trade location in exchange for greater confidence that the market will continue to move in the direction of trade entry.
The good news is that breakout strategies have a high win/loss ratio. The bad news is that whipsaws can be brutal!
Conditions Preceding a Trend Day
Several key price patterns can serve as alerts to the potential for significant range expansion:
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NR7 -- the narrowest range of the last 7 days (Toby Crabel introduced this term in his classic book, Day Trading With Shortterm Price Patterns and Opening-range Breakout);
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A cluster of 2 or 3 small daily ranges;
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The point of a wedge-type pattern (which usually exhibits contracting daily ranges);
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A Hook Day (wherein the open is above/below the previous day's high/low -- and then the price reverses direction; the
range must also be narrower than the previous day's range; leads traders to believe that a trend reversal has occurred,
whereas the market has instead only formed a small consolidation or intraday continuation pattern);
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Low volatility readings, based on such statistical measures as standard deviations or historical volatility ratios or indexes;
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Large opening gaps (caused by a large imbalance between buyers and sellers);
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Runaway momentum (markets with no resistance above in an uptrend or no support below in a downtrend. This condition
differs from the above setups in that volatility has already expanded. In a momentum market, however, the huge imbalance
between buyers and sellers continues to expand the trading range!)
Fading extreme tick readings can be dangerous - On a trend day, a countertrend strategy of fading extreme tick readings could result in
substantial losses.
Ave. True Range highlights range contraction/expansion - The 3-Day Average True Range Indicator highlights how cyclical the
phenomenon of range contraction/range expansion is. Volatility tends to be more cyclical than price.
Trading Strategies
A breakout strategy, or intraday trend-following method, can best capture a trend day. Wait for the market to tip its hand first as to
which direction it is going to trend for the day. Rarely can this be determined by the opening price alone. Thus, most breakout
strategies enter only after the market has already begun to move in one direction or the other, usually by a predetermined amount.
Add the following techniques to your repertoire. All of them will ensure you participate in a trend day.
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Breakout of the Early-morning Trading Range. The morning range is defined by the high and low made in the first 45-120
minutes. Different time parameters can be used, but the most popular one is the first hour's range. Wait for this initial range
to be established and then place a (1) buy stop above the morning's high and a (2) sell stop below the morning's low. A
protective stop-and-reverse should always be left in place at the opposite end of he range once entry has been established.
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Early Entry. Toby Crabel defined this as a large price movement in one direction within the first 15 minutes of the opening.
The probability of continuation is extremely high. Once one or two extremely large 5-minute bars appear within the first 15
minutes, a trader must be nimble enough to enter on the next "pause" that usually follows. With many of these strategies,
the initial risk can appear to be high. However, a trader must recognize that as the trading volatility increases so too does
the potential for good reward.
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Range Expansion off the Opening Price. A predetermined amount is added or subtracted from the opening price. Though
Toby Crabel also described this concept in his book, it was really popularized by Larry Williams. The amount can be fixed, or
it can be a percentage of the previous 1-3 days' average true range. With resting buy and sell stops in place, the trader will
be pulled into the market whichever way price starts to move. Entry, often made in the first hour, can be made earlier than
the breakout from the first hour's range. In general, the further price moves away from a given point, the greater are the
odds it will continue in that same direction. The ideal is continuation in the direction of the initial trend once the trade is
entered.
Volatility tend to increase as a trend matures - Trend days also frequently occur in runaway momentum markets. There is little range
contraction evident in the latter part of this trend move. Rather, emotions run high as the imbalance between supply and demand
reaches an extreme.
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Price Breakout from the Previous Day's Close. This strategy is similar to the above, but with buy and sell stops based on a
percentage of the previous 1-3 days' range added to the previous close. The advantage to using the closing price is that
resting orders can be calculated and placed in the market before the opening. The disadvantage is the potential for whipsaw
if the market moves to fill a large opening price gap.
(Another version of a volatility breakout off the open or closing price is the use of a standard-deviation or price-percentage
function instead of a percentage of the average true range. All the above methods can be easily incorporated into a
mechanical system.)
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Channel Breakout. One of the more popular types of trend-following strategies in the nineties, Donchian originally
popularized the concept by employing a breakout of the 4-week high or low. Later, Richard Dennis modified this into the
"Turtle System," which used the 20-day high/low. Most traders don't realize that simply entering on the breakout of the
previous day's high or low can also be considered a form of channel breakout. (Another popular parameter is the 2-day high
or low.)
Exit Strategies
One of the easiest and more popular ways to exit a breakout trade is simply to exit "Market-On-Close. " The ideal trend day closes near
the opposite extreme of the day's range from the opening. This strategy keeps the trader in the market throughout the day, yet
requires no overnight risk. Most breakout strategies actually test out better for trades held overnight because the next opening will so
often gap in a favorable direction. Thus, another simple strategy is to exit on the next morning's opening.
Instead of a strategy based on time, such as the close or the next day's open, one can also use a price objective. One popular method
is to take profits near the previous day's high or low. One can also determine a target based on the average true range.
For the classic market technician, point-and-figure charts can provide a "count" which establishes a price target. This method is valid
only if price breaks out of congestion or a well-defined chart formation.
Trade Management
In general when testing volatility breakout systems, the wider the initial money-management stop, the higher the win/loss ratio. With
breakout strategies, the initial trade must be given room to breathe.
However, a discretionary day-trader will learn that the best trades move in his favor immediately. In this case, move the stop to
breakeven once the trade shows enough profit. The stop can be trailed as the market continues to trend, but not too tightly. Because a
great majority of the gains can occur in the last hour as the trend accelerates, try not to exit prematurely.
When trading multiple contracts, scale out of some to ensure a small profit in the event of a reversal. However, do not add to a
position: The later the trade is established, the more difficult it is to find a suitable risk point.
A Few Words on Volatility Breakout Systems
Trading a mechanical breakout system can provide invaluable experience. The average net profit for the majority of these systems is
quite low, so they may not guarantee a road to riches; but they serve as a terrific vehicle to gain a wealth of experience in a very
structured format.
If you are going to trade a mechanical system, you must be willing to enter all trades! It is impossible to know which trades will be
winners and which ones losers. Most traders who "pick-and-choose" have a knack for picking the losing trades and missing the really
big winners. The hardest trades to take tend to work out the best! With most systems, a majority of the profits come from less than
5% of the trades.
Though most breakout methods have a high initial risk point, their high win/loss ratio makes them easier to trade psychologically. You
might get your teeth kicked in on the losers, but, fortunately, big losses do not happen very often. Also, if trading a basket of markets,
as one should with a volatility breakout system, diversification should help smooth out the larger losses.
To summarize the main benefits of trading a breakout system:
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It teaches proper habits, in that there is always a well-defined stop;
You get lots of practice executing trades;
It teaches the importance of taking every trade;
It teaches respect for the trend.
Additional Considerations when using Breakout Strategies
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Overall average daily trading range (must be high enough to ensure wide "spread");
Volume and liquidity;
Seasonal tendencies (e.g., grains are better markets in spring and summer);
Relative strength;
Commercial composition.
Volatility Breakout System - An equity curve for a simple volatility breakout system that enters on range expansion off the previous
day's CLOSE and exits the next day. Once again, the market opened on one extreme of its range and closed on the other. It made a
steady pattern of lower highs and lower lows all day.
Volatility Breakout System - This volatility system is based on range expansion off the OPENING price and then exiting on the next day's
close. Over the long run, entering on range expansion off the opening price or off the previous day's close does equally well. In this
case, entering on a breakout off the opening price resulted in a higher equity peak at one point but a larger drawdown later.