A Simple Swing Trading Strategy
Swing trading is a simple way to trade currencies which can make great profits and a major advantage of this method is &8211; you don&8217;t need the as much discipline as you need to hold long term trends, as losses and profits come very quickly.
I have always believed, that having the discipline to take losses is relatively easy if you believe in your system but holding longer term trends is far harder. The reason for this is obvious:
If you are following long term trends, you will be sitting on a big open equity profit, when the inevitable, short term pull backs come against you and eat into the profit, the temptation is always there, to take a profit in rather than let it run.
Trend following means having an open target and in addition, you know that you have to give back a good bit at the end of the trend, as no one knows when a trend in motion is going to end but in swing trading, you will have a set target and when its hit &8211; you are out. Both profits and losses come quickly and this means, you don&8217;t have to have the mental discipline which you need as a long term trend follower and this of course makes swing trading ideal for novice traders.
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The Concept of Overbought and Oversold
If you look at any FX chart, you will see trends but these trends, will have reactions to the upside and downside where prices are pushed to far up or down, away from the average price, but prices will always return to more realistic levels. The aim of the swing trader is &8211; to sell into overbought levels and buy into oversold levels and liquidate the trade, when prices have returned to fair value.
Markets will always spike to far up or down in the short term, because humans are emotional beings and they make trading decisions based upon greed and fear. This concept is easy enough to understand and will always occur, because human nature is constant and greed and fear are reflected in the chart as overbought and oversold levels.
Waves on a Beach
Over the years I have seen some incredibly complex swing trading systems and seen traders who use them, fail with them. When swing trading, you need a simple system because all you are doing is trading the odds and when trading the odds, a simple system will be more robust with fewer parameters to break.
Swing trading is a bit like watching waves on a beach when the tide comes in; You know the tide is going to come in its inevitable but as the waves hit the beach and go backwards and forwards, as the tide comes into the shore, each wave is different in terms of how far it comes in and how far it pulls back.
In the markets its a similar concept, every scenario is different and while we will lay down some general guidelines, these should still be reviewed by you, in light of the individual trading scenario you are looking at. I do not think swing trading can be reduced to pure set rules and an outline of rules which you can review on each pair and pull the trigger on is a far better way of trading.
Trading Pairs and Duration
In terms of swing trading there is no best currency pair to trade, you can trade any of the major currencies or crosses. As long as you have good liquidity, volatility is high and pip spreads are tight, you can swing trade a currency pair – so how long does a typical trade last?
A typical swing trade, will last from between a day and a week and one point we want to make clear &8211; is that each currency may give you 2 – 4 good swing trades a month. You only want to trade when the set ups are right! I see many traders looking to trade everyday but this just means making effort for efforts sake and you don&8217;t get rewarded for that, just being right. So in conclusion, always be selective in your trading and keep the odds on your side.
Trading Indicators for Swing Trading
Let&8217;s first look do a quick summary of the 3 indicators we normally use and then apply the MACD into the mix.
Below we have outlined the various indicators and the logic behind them and then we will give you some tips on combining them into a simple strategy. These are all visual indicators and you don&8217;t need to know how an internal combustion engine works to drive a car and its the same with technical indicators, just look at the visual set ups and you will do just fine.
1. The Relative Strength Index (RSI)
The RSI was introduced to traders by Wells Wilder in 1978 in the legendary book New Concepts in Technical trading and is one of the most widely used momentum indicators in Trading.
General Rules for Using the RSI
It is recommended to use 70 and 30 and overbought and oversold levels respectively. Generally, if the RSI rises above 30 it is considered bullish and on the other hand if the RSI falls below 70, it is a bearish signal.
Like MACD, RSI divergence and convergence are really good trade setups. Usually, the currency will reverse very soon when the RSI divergence and convergence occur on the chart. When the market is overbought, RSI Divergence is a great trade setup to go short. We have illustrated a high and low in price with divergence on the RSI.
The RSI is a tool which is useful but it is not effective on its own in our view and should be used as a back up tool and we like to use it in terms of supporting our favorite timing indicator the stochastic.
This is an indicator which was developed by George C. Lane in the late 1950s and while its been around for half a century, we still consider it the ultimate indicator for timing trading signals and its based on a very simple concept:
General Rules for Using the Stochastic
Below 20 is considered oversold and above 80 is overbought. However, reading below 20 or above 80 does not mean that the market will reverse. When using the stochastic by its very nature you will get a lot of false signals so you need to trade extremes if using it on its own – you can trade levels which are not extremes and we will look at how to do this in a moment and how to filter signals.
3. The Bollinger Band
As I see we have a detailed article about Bollinger Band on middleground. Therefore, it is recommended to read that article to learn about Bollinger Bands in details: How to Use Bollinger Bands
Trading Set Ups Using &8211; the RSI Stochastic and Bollinger Band
This simple method combines the volatility of the Bollinger Band to isolate overbought and oversold levels to set up possible swing trading scenarios and adding the RSI and Stochastic in as the timing indicators to enter the trades. Lets take the graph we have just looked at above and add these indicators in:
So general rules of the above method are:
- Look for high volatility and a price spike up or down. Prices need to be at the outer band or even better if they have exceeded it, as per the above example.
- Look for the stochastic to be at overbought or oversold and a turn up to occur.
- Look for the RSI to support the move but as its a supporting indicator prices do not need to be overbought or oversold ( if they are all the better) but they should support the stochastic.
- When the trade is entered, the stop is below the relevant support and resistance level you are trading into.
- Target should be a support or resistance level near the Mid Bollinger Band. In many of the above scenarios, prices run on but this is not the object of swing trading; your aim is to set a target just before support is hit, when you are trading short and just before resistance is hit, if you are trading long.
4. The MACD
There is also a good article about MACD on middleground. Please read it to learn about MACD and the way it can be used: How to Use MACD
Using The MACD with Bollinger Bands, RSI and the Stochastic:
Now lets take the above chart and add in the indicators above and see what the combination looks like and how the indicators come together. We use the stochastic as our main tool to enter trades and the advantage of combining it with the MACD is that it will allow you to filter trades better in terms of entry – this will become clearer if we look at some charts.
When using the above indicators keep the above in mind as general guidelines:
1. Always look to trade on high volatility on spikes to or outside of the bands.
2. Look at the MACD lines in view of &8211; the further away from the centre line the better in terms of spotting trading opportunities.
3. When looking for trading scenarios – look for the MACD line to lose momentum and check the stochastic and RSI.
4. If the stochastic is at an extreme and the MACD line is losing momentum – your signal to sell, can be from the stochastic so long it is overbought or oversold. The MACD line does NOT have to cross ( the stochastic will normally turn first of course) when the MACD does cross though, it will provide additional confirmation for the signal. You should also on all highs and lows, watch the MACD histogram for additional confirmation of falling momentum.
5. The RSI does NOT have to be at an extreme when you enter a trading signal – if it is, it adds weight to the move but so long as it supports the direction you wish to trade in that&8217;s fine. 6. When setting a target, this will depend on how extreme the move is &8211; but as a general rule, we always look for support or resistance levels, around the mid Bollinger Band in strong trends.
If you use the above general guidelines and trade into price spikes on high volatility, you will have a flexible and powerful set of tools, with which to generate high return, low risk trading signals.