With the strong trends exhibited by stocks, swing trading has become increasingly popular among traders. In fact, the swing chart is the most common technique used to identify trends.
In this article, we look at how to draw swing charts and, more importantly, how to use them to profit.
- Swing trading is a style of trading that attempts to capture gains in a security over a period of a few days to several weeks based on changes in momentum.
- Technical analysts can use charting techniques to identify potential entry and exit points for a swing trade.
- Swing charts can be constructed by identifying near-term highs and lows that have occurred to identify trends.
Why Use Swing Charting?
Swing charts are extremely useful tools for technical analysis, and here are some reasons why this technique is so popular:
- Swing charts show nothing but trends, greatly simplifying the process of locating them. Remember, trends are the primary means to profit in any market.
- Swing charts exhibit less market "noise," which can help you more accurately apply other forms of technical analysis that aren't time-sensitive.
- There are several variations of this technique—such as Kagi charts and Gann-based swing charts—that offer a more complex way to locate trends. These techniques also offer the option of making many empirical changes to further enhance trend-finding abilities.
Constructing a Swing Chart
Swing charts, in their most basic form, are composed of price bars, which represent price behavior during a given time.
Here is a simple bar chart we will reference throughout this article:
Most technical traders have probably seen a bar chart, as it is the most common type of chart. The vertical lines represent the price range, the left peg represents the opening price, and the right peg represents the closing price during a given time period.
There are many different ways to construct a swing chart using highs and lows. For this article, we will focus on the popular and effective Gann swing charting method. Here are the four basic turning points in this type of chart:
- Up day: Higher high and higher low (green).
- Down day: Lower high and lower low (red).
- Inside day: Lower high and high low (black).
- Outside day: Higher high and lower low (blue).
Here is the same bar chart as above, classifying every bar as one of the four turning points:
We have now identified the beginnings and ends of several trends using the four different turning points. To construct the swing chart, we must remove time as a factor and instead focus solely on price action. To do this, we must find two points:
- Up day that is followed by a down day
- Down day that is followed by an up day
These two points indicate when a trend begins or ends and, as such, a time to enter or exit a swing trade. Now that we have marked these points, we can construct the actual swing chart. To do this, we first eliminate the time factor by moving the points together in equal intervals while maintaining the order.
After this, simply connect all the points to complete the chart. The end product should look something like this:
Notice that the time factor has completely disappeared, and it is significantly easier to see price trends.
Using Swing Charts
Swing charts can be used in a variety of ways:
- To easily view the overall trend of a market or equity: Trends can be discerned by simply looking for progressively higher highs and lows (which form a stair-like pattern) or by drawing trendlines.
- To easily position "stop-loss" and "take profit" points: Previous highs can be used as take-profit points, and previous "step" bottoms throughout a trend can be used as moving stop-loss points.
- To apply technical analysis techniques that are not time-sensitive: For example, Fibonacci levels can be calculated, or Elliott waves can be applied. These can often help you predict where prices are headed, or can help you place more effective take-profit and stop-loss levels.
- To create price channels: These can be developed by connecting consecutive highs and consecutive lows. This can help predict prices, place moving take-profit and stop-loss points, or help you liquidate or add to a position in a timely manner. Placing lines that connect highs to highs and another line connecting lows to lows creates a channel through which the price moves.
The Bottom Line
Swing charts offer an easier way to view trends by removing market noise and the time factor. They can be used in conjunction with several forms of technical analysis to obtain more accurate predictions and take-profit and stop-loss points. There is an old market adage: "The trend is your friend." Swing charts can help you find it.