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The typical swing occurs as part of the normal trading cycle, the interac-tion between buyers and sellers. It reflects the never-ending greed/fear emotional mindset that dominates short-term trading, and is a continual adjustment of price perception on both sides. Swing trading occurs natu-rally as part of this never-ending swing pattern.

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FIGURE 4.8 Power Spike: Alberto-Culver Source: Candlestickchart.com.

This action/reaction (the reaction swing) occurs as a series of price corrections within a larger, longer-term trend. The various patterns tech-nical analysts use in chart study—such as triangles, wedges, flags, and pennants—all are part of this correction trending. They help you to pre-dict how and when direction of price is going to change. The trick is in the timing.

Swing trading and the prediction process must involve the count of trading cycles. This is why emphasis is placed on the typical two- to five-day period. This is where swing trades usually occur. In a continuation of a strong trend, you can go along for the ride of a trend when the maxi-mum five days are exceeded. Figure 4.8 provides an example of such an opportunity. Following a two-part signal (upper shadow spike with high volume, and classic three-day downtrend ending with an engulfing line) the buy signal could not have been stronger. At the low point, the swing trader knew it was time to buy. Yet instead of a two-to five-day cycle, the ensuing uptrend extended at least eight days and possibly more. The in-teresting point in this pattern was that, lacking any reversal signal (in price, volume spikes, or bearish price gaps), the swing trader would be likely to hold on through the entire upswing, no matter how long it would last.

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Swings are a natural occurrence, reflecting an interaction be-tween buyers and sellers. Recognizing the action/reaction that occurs in all stocks is how swing traders earn profits.

Key Point

Some swing trading cycles extend beyond the five-day window and, without a reaction change signal it is easy for swing traders to move too quickly. This leads to missed opportunities and, possibly, to losses.

Key Point

The series of three periods occurs so frequently that swing traders can find themselves making decisions on false signals prematurely. Figure 4.8 contains a good example of this. If you look at the strong uptrend following the spike and downtrend, after three uptrend days, the stock showed one black real body. It was not an engulfing line, a narrow range day, or a high-volume day. Even so, it did follow three uptrend days, so some swing traders would take profits at that point and sell. The prob-lem with this is that there is not a sell signal. If a swing trader is going to react to a three-day trend, then there are plenty of pitfalls along the day.

It leads to poor timing. This is why the reaction swing requires a signal of the price moving in the opposite direction. So either the narrow range day or an engulfing line is essential to the timing of swing trades. With-out one of these, you really cannot know whether the short-term trend is over or will continue.

The problem swing traders face is distinguishing between the two-to five-day trend and actual momentum. With momentum, you need to wait out the exhaustion of the trend, even though it may move beyond the two-to five-day window. Figure 4.8 demonstrates this in the strong uptrend at the conclusion of the chart. To its very end there exists no sig-nal that momentum is over. In fact, the two price gaps in the trading peri-ods four and five days prior to the chart’s end give strong evidence that the trend will continue. This runaway gap moves the stock above the estab-lished trading range (not counting the spike) and continues the uptrend.

Swing traders cannot rely on repetitive and consistent patterns, as this example demonstrates. In fact, the power spike may precede mo-mentum, even when that momentum runs in an opposite direction. The uncertainty of how price moves after a power spike serves as a warning as well as an opportunity. For example, given the failure of Alberto-Culver buyers to move the stock into higher territory on the day of the spike, it would be reasonable to conclude that the stock would move downward.

It did, but only for three days. If momentum were to occur after the spike, it stands to reason that, failing the attempt to move price higher, that momentum would be downward. The typical swing trade pattern of three down days ending with a bullish engulfing line contradicted this, however, and the momentum move was up. In this case, the spike was only a first attempt; ultimately, buyers did prevail and the price did move up beyond established trading range.

In managing the reaction swing, you may seek further types of sig-naling events. The obvious ones are clear: three or more days of specific trends are always necessary (higher highs and higher lows indicating an uptrend, and lower lows with lower highs indicating a downtrend). In addition, you need to identify strongly confirming signals, of which there are three common types. These are the narrow range day, higher than average volume, or the engulfing line. When higher than average volume accompanies either the narrow range day or the engulfing line, it is the strongest possible type of confirmation.

There are additional confirming signals. On the upside, when a stock reaches a new high, for ex-ample, that may confirm the end of a recent up-trend as part of a swing trade timing strategy. A new high is usually defined as a high price for the past 52 weeks and, while such an occurrence is un-likely to show up frequently, it may be used as con-firmation that a current swing trade is about to be exhausted.

A new low is the equivalent confirming signal at the end of a swing trading downtrend. Once sell-ers have driven prices down to a record one-year level, it is more likely than ever that a reaction swing will occur.

However, because swing traders are less interested in long-term trends and more intent on short-term price changes, confirmation does not need to take the form of a 52-week record. When a stock has been trading in a narrowly defined trading range, and breakout above or be-low that level will establish immediate record high or be-low levels based on

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A power spike can be interpreted in more than one way. A cau-tious trader may want to wait and see which direction prices will move before entering a post-spike trade.

Key Point

new high the highest price a stock has reached during the past 52 weeks.

new low

the lowest price a stock has reached during the past 52 weeks.

the established range. In fact, the breakout new high or new low may pro-vide stronger immediate confirmation than a one-year record. If, for ex-ample, a stock has been hovering within a three-point range for nine months, and inches slightly above or below that narrow range, how signif-icant is the change? For swing trading purposes, it may be more important to observe a stock cycling within three points for a month, and suddenly jumping above or below that shorter-term trading range—not for long-term investing purposes, for solely for swing trading confirmation.