A Swing Trader’s Guide to Buying the Dip

Charting the Market Educational Series

Swing trading is one of the more popular techniques for investors in the stock market. It combines powerful tools for risk management and technical analysis. Here’s how it might work for you.

The Trend Is Your Friend

Stocks often move in a clear direction over time, with consistently higher highs and higher lows. Swing traders attempt to follow these trends by purchasing shares as they continue upward after basing. They might begin new positions or add to names they’re holding over the longer term.

Moving averages can help swing traders spot trends. Some stocks may rally for months without touching a key moving average like the 50-day simple moving average (SMA). Then, buyers jump in as it pulls back to test that level.

Still, a word of caution: Moving averages work until they don’t. The more often a stock bounces at one, the more likely it is to fail.

Waiting for Confirmation

Say a stock is trending higher and suddenly pulls back. We don’t want to buy shares blindly because it might keep dropping. How do we know that it’s stabilizing and ready to continue its longer-term rally?

Weekly charts can help by showing price action more clearly. Each candlestick represents five sessions of trading, so they can provide much more confirmation.

First, the 10-week SMA can be a great reference for showing uptrends. (This closely tracks the 50-day SMA.) Next, we can look for certain patterns as the stock pulls back to approach the moving average:

  • Inside week, followed the next week by a break above the inside week’s high. This requires three candlesticks. The first one is a point of reference. The second one needs to fit entirely within the first one, with a higher low and a lower high. The third candlestick needs to close above the high of the second one.
  • A break of multiweek resistance. If a stock is trapped below a single high for several weeks, we look to buy as it pushes through that level.
  • A weekly reversal candle, followed by a new high. We’re looking for a candle with a long tail closing near its high, also known as a hammer. The trigger occurs when the next candle surpasses the high of the hammer.

The Problem With Breakouts

A huge benefit of this method is that it prevents you from chasing breakouts. We’ve all seen a stock flying higher for months and been frustrated that we don’t own it. Then it hits a new high and we buy it near the top.

Just as we don’t want to blindly buy a stock as it’s dropping, we also don’t want to recklessly amass shares as they soar upward. After all, that prevents setting good stop-loss levels. That translates into a poor risk/return and an unfavorable edge.

Key Things For Swing Traders to Watch

There are some other techniques swing traders may want to use.

First, look for stocks with a large open distance above their rising 10-week SMAs. These might trend higher for several months without giving a favorable entry.

We need the discipline to wait for a pullback to the 10-week SMA. Stocks will often draw buyers out of the woodwork by testing it just once. After that, some of the patterns outlined above can take shape.

Next, you can set alerts and wait. Some large investors hold off buying until they get a test of the 10-week SMA or the 200-day SMA. If we resolve to wait for the alert, it can keep us from getting emotional and buying at the wrong time.

This brings us to one of my favorite signals: a long time between tests of a moving average. Some upward trending stocks might only tag their 10-week SMA once or twice a year. Waiting for those rare occasions can be very profitable.

On the other hand, repeated contact with a moving average can be a problem. The more often a line is tested, the more likely it is to break.

Swing Trader’s Checklist

In conclusion, these are the key points for swing trading:

  • Swing trading follows trends, targeting stocks with a clear direction. We’re not looking for reversals or bounces from long-term lows.
  • Swing traders should use weekly charts to identify both trends and potential entries.
  • Swing traders should wait for confirmation from patterns like inside weeks.
  • Swing traders should avoid chasing breakouts because they have poor risk versus reward.
  • Swing traders should use moving averages to spot trends and potential entries.
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