Swing trading doesn't come with guarantees. You have to stack as many factors as possible in your favor to improve your odds of success. Stock market direction is one of the most critical components. Even the most ideal patterns have trouble bucking a market trend in a different direction. Here's how to simplify what to look for.
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IBD's SwingTrader has a market action column that dissects the current stock market direction. Three arrows summarize the environment: uptrend, sideways, or downtrend. The factors determining which arrow we use include the daily price and volume action in the leading indexes, their price action in relation to short-term moving averages, excessive price swings in either direction, and individual stock strength.
Swing Trade More When Market Direction Is Up
The most favorable time to swing trade is when the market direction is up. We start with the leading index. Just comparing performance of the major indexes can give you an indication of which is the leader. If you are seeing strength across the board, that's even better. The expanded breadth improves your batting average. You just need to focus on the stocks that can make the most money when you are right.
Strong group and sector moves often produce the biggest winners within them. The stocks that resisted the previous correction tend to be the first ones out of the gate when the stock market direction turns. Identify them by their relative strength lines going up at steep angles and making new highs ahead of the price. Reversals and breakouts start your trades, and taking profits on the way up will finish them. In the cases where it doesn't work, cut the loss quickly and move on. In these environments new stock ideas come up often.
Since our time frame for swing trades tends to be around 10 days, it's logical to use the 10-day moving average line to help you gauge the short-term market direction. In addition to whether the index is above or below the line, you should also observe the direction of the line itself. Is it up, down or flat? This should also be viewed in conjunction with an overall uptrend in longer-term moving averages like the 50- and 200-day lines.
Sometimes the uptrend may start more tentatively from a sideways move. On May 9, we noted a stock market direction change in the major indexes. They all got above their 50-day moving average lines (1) and wemoved the market direction arrow to uptrend. A bearish reversal just a few days later (2) stymied progress for a while. But the index remained above its 10-day moving average line. On May 30, the Nasdaq composite got back above its 5-day moving average line (3) and remained above it for nearly a month.
Swing Trade Less In A Sideways Market
Nothing lasts forever and when the market starts to flatten out, caution should rule the day. Most recently, SwingTrader went to a sideways trend on June 22 (4). A few days prior, we noted the extended nature of most leaders. New setups lacked strong relative strength. We had already noted that the S&P 500 and Dow Jones industrial average had fallen below their 10-day moving averages and were in sideways trends. The action on June 22 showed a flattening 10-day line on the Nasdaq and confirmed the earlier caution.
This is where discipline as a trader comes in. It can be tempting to go after stocks, trying to recapture the gains from the previous rally. A few stocks will make it seem like it's worth the effort. But the majority will go against you. Why trade when the odds aren't favorable?
As an example, after a change in stock market direction to sideways trend in June, the back-and-forth action that followed in the Nasdaq was unnerving. Markets kept staging bearish reversals, starting strong and closing weak (5). That action can easily shake you out of positions and it was happening every other day. What made it worse? The weakness would spill over to the next day's trading session to make sure it knocked you out. Then the market would turn around and close near its peak for the day (6). This can make you doubt the necessity for stop losses and tempt you to retake positions only to start the cycle over again.
Understand it's the short-term nature of swing trading that can make this type of environment particularly damaging. If you have positions that you held for a few months with plenty of cushion, it changes the math. Having back and forth action for a few weeks is something you can sit through. For short term trading, it's best to just sit it out.
When Is The Best Time To Short Stocks?
Invariably, many traders still want some action. If the market won't cooperate on the upside, they start quickly looking on the short side. Shorting stocks, to put it bluntly, is tough. The timing needs to be spot on and you are constantly fighting the overall optimism people have for things they own. Even the hint of a positive rumor can send stocks vaulting and your short positions become losers. Downtrend arrows are for times when shorting may be more favorable.
Don't try to go short right after a market top. It's best to wait for a downtrend to establish itself. The longer-term moving averages, like the 50- and 200-day lines should be flattening or turning down as well. Sometimes shorting opportunities will come after prolonged sideways action loses a support level. You also don't look at stocks flashing sell signals from the long side as your watch list for shorts. You should allow the downtrend in the individual stocks to develop as well. Lagging price action below the moving averages like the 50-day line and weak relative strength are the characteristics to look for.
The February correction shows the perils of shorting too early. The correction started in earnest at the end of January and hit its low on Feb. 9. That's not much time for short positions to work. By the time things started to look really bad, they were bouncing strongly just a week or two later. Again, when it's not a favorable time to make money it's best to sit on your hands. Your focus should switch from making money to not losing money.
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