How To Swing Trade: A Beginner’s Guide to Trading Tools, Money Management, Rules, Routines and Strategies of a Swing Trader

by Brian Pezim

It is a commonly held rule of thumb that stocks fall 3 times faster than they rise.

BULLS TAKE THE STAIRS UP; BEARS TAKE THE WINDOW DOWN.

A large number of excellent resources are available on the Internet including, but not limited to, the following: Finviz (finviz.com) ChartMill (chartmill.com) StockCharts.com (stockcharts.com) Estimize (estimize.com) StockTwits (stocktwits.com) CNBC (CNBC.com) Yahoo Finance (finance.yahoo.com)

One of the obvious choices for swing trading is with individual company stocks. As I have discussed already, there are pros and cons to holding individual stocks. Holding an individual stock can expose you to single event risk.

you can get much better returns by investing in individual stocks but you also take on more risk by putting your money into a single stock with the potential of single event risk.

The following 4 items are required to define a stock option: the stock that the option is being applied to (AAPL, IBM, etc.) is it a “call” or a “put” the strike price the expiry date of the option

you can buy 100 FB shares for $17,000.00 or you can buy a $180.00 call option for $1.90/share that expires April 20th (at the time of writing, $1.90/share was the quoted market price to purchase this $180.00 call). Your 100-share investment in FB costs you $190.00 plus commission ($1.90 x 100 shares). Now you need FB to go up to over $181.90 per share to break-even on the trade ($180.00 strike price plus the $1.90 you paid for the options on 100 shares).

Playing a stock to the downside is also equally easy. Instead of buying a call, you would buy a put, which gives you an option to sell the stock before expiry.

I do not trade options except on rare occasions and I do not recommend any trader participate in the options market without much more research than this book is providing.

To protect your capital, there are 4 very important processes a successful trader must use: properly assessing the risk and the reward setting stops and targets managing the dollar size of the trade maintaining a journal of trading activity to measure and improve performance

To have a good trade setup, you should expect to get at least 2 times the reward in comparison to the risk that you are taking.

A good trade setup will always offer a swing trader 2 times or more reward for the risk that they are taking.

The stop-loss is a must for a successful trader and is one of the most important tools a trader will use to preserve their capital.

As a swing trader, you must accept that the market is always right – no matter how wrong you think the market is!

Remember these words of wisdom from the famous economist John Maynard Keynes: “The market can remain irrational longer than you can remain solvent.”

Most experienced traders use the “rule of thumb” that says you should not put more than 2% of your capital at risk on any one trade.

Assume you are looking at a stock that is trading at $10.00/share. The price movements are looking like it will go higher and you want to take an entry because it looks like it could head to $10.75 where it will find some price resistance. You like this trade because it looks like there is price support around $9.75 where it made a low on some bottoming price action. So if you get an entry price of about $10.00/share, then you are risking $0.25 ($10.00 - $9.75 stop) to make $0.75 ($10.75 exit - $10.00). This is a good trade because the reward is 3 times the risk (reward $0.75 versus $0.25 risk). Remember, I said you should expect to get 2 times or more reward for the risk you take.

Maintaining a Trading Journal

Because your trades will unfold over days to weeks, it may be best to keep some sort of log – either an electronic-based or paper-based recording system.

Regardless of what you chose to use, the following are items I suggest you keep track of before placing a trade, after the trade is placed and when the trade is closed: date market internals: i.e., conditions overall, S&P, Nasdaq, industry sector source of trade idea reasoning to enter trade sector alignment: is the trade you’re considering aligned with the market and sector direction technical indicators including RSI and MACD values (discussed later in this book) check for upcoming events to avoid holding through entry price stop price target price a risk to reward ratio > 2 actual entry price actual exit price profit/loss comments: whatever seems relevant to you at the time, this may include notes on the trade as well as your execution and your level of confidence versus the actual trade result

Before entering any trade, you can take your journal and ask yourself some basic questions: How am I feeling mentally: am I able to make rational and non-emotional decisions right now? Does this fit into my trading personality and my risk tolerance? What strategy will this fit into? If this trade goes the wrong way, where is my stop? How much money am I risking in this trade, and what is the reward potential? Be in touch with the results of your decisions and constantly be reviewing your performance. Are you trading profitably? Have you had 5 wins in a row or have you had 5 losses in a row? If you are on a losing streak, will you be in touch with your own emotions and maintain your composure, or will you let your judgment be impaired?

Respect your target price and do not take profits too early and thus change your original trade plan and the risk to reward ratio you had established earlier.

Constantly review your existing trades to ensure that nothing has changed fundamentally in the stock, sector or market. This is the only reason you should consider changing your trade plan.

Maintain your trading journal and review it regularly to determine what works and what needs to be changed.

That data can include one or more of the following: total revenue earnings per share (EPS) price to earnings ratio (P/E) leverage: the amount of debt to equity product pipeline: future potential growth driver competitive advantages a company may have over competitors conditions that might favor or disadvantage a particular sector/commodity company management peer-to-peer comparisons regulatory environment and pending changes short interest hot sector manias

Fundamental analysis has significant relevance for a value investor like a Warren Buffett.

Let’s look at a few of these important factors in more depth and then examine the one I feel is the big winner. I will cover the following stock fundamentals in this chapter: total revenue earnings per share (EPS) price to earnings ratio (P/E) debt to equity ratio return on equity (ROE) short interest hot sector manias

It is often a good indicator that a company is doing well if its revenue is growing at a steady pace year over year. If the revenue numbers are flat or dropping year over year,

The Estimize site is a good source of information because they crowdsource earnings and economic estimates from over 72,000 hedge fund, brokerage, independent and amateur analysts. Collecting and presenting estimates from a wide community of experts and amateurs often provides a more accurate set of financial numbers compared to an investor referencing only a couple of sources.

Earnings are calculated by taking the total revenue and subtracting the direct costs of production.

Simply put, the long-term value of a company is based on the future cash that the company will generate in its business.

However, earnings are only part of the equation. To get a real understanding of the value of a company and how it compares to the value of another company, you need to look at the earnings per share (EPS). To arrive at this number, you take the earnings and divide it by the number of shares outstanding.

that company has an EPS of $5.00 per share. Knowing the EPS of one company makes it easier to compare that company to others in a similar business.

The P/E gives you a view of how the market is pricing a company’s shares in relation to its earnings. It is calculated by taking a company's price per share (P) and dividing by its earnings per share (E). For example, if a stock is priced at $100.00 per share and it has an EPS of $10.00 per share, then the P/E ratio is 10

A higher P/E ratio means investors are willing to pay more for each dollar of annual earnings.

You can use this number to compare how investors are valuing other companies in t...

higher P/E in relation to other companies in the same sector indicates that investors are f...

If you do a search for stocks that are appropriate to take a long position in, you could include this factor in your scan. Look for the companies that have a debt to equity ratio of less than 1.

Return on equity (ROE) is a measure, expressed as a percentage, of how much profit a company generates with the money shareholders have invested.

Companies with higher and growing ROE numbers tend to be more highly valued by investors.

The level of short interest is an indicator of market sentiment for a stock. If the short interest is under 5%, there is some level of negative sentiment but it is not extreme. There will always be some traders and investors who feel a company is overvalued. If the short interest is over 20%, then it is an indication that a significant number of traders have a negative opinion on the stock and hold a strong conviction that the stock price will go down.

While a high level of short interest indicates a negative sentiment, it can also be a catalyst for a strong price increase.

Let us say that a stock with a high level of short interest releases some unexpected good news. Buyers immediately enter the market and purchase shares based on the news, which drives the price up. Short sellers start to worry that they are going to have to buy the shares back at much higher prices so they start to cover their short positions by purchasing shares as well. This additional purchasing adds to the buying frenzy. This event is referred to as a short squeeze and it can result in very strong upward price moves depending on how many shares are shorted and the size of the float.

at the one that I feel has by far the greatest potential to create a good swing trade setup. This is by no means a big secret. It is a well-known fact that catching a popular sector early is like grabbing a tiger by the tail. Once you grab one, hold on for the ride. I refer to this phenomenon as “hot sector manias” because all investing common sense seems to be abandoned by investors and traders.

There are a few fundamental analysis tools that a swing trader with very little accounting experience can use when searching for trading opportunities: - total revenue - earnings per share (EPS) - price to earnings ratio (P/E) - debt to equity - return on equity (ROE)

The level of short interest provides some insight on the sentiment of traders toward a stock.

The best fundamental analysis factor for a swing trader is finding and investing in hot sector mania plays.

Your goal, as a successful swing trader, is to discover the balance of power between the buyers and the sellers and then bet on the winning group.

These patterns include the following: engulfing pattern doji: harami cross doji: gravestone and dragonfly

Engulfing candle: one large candle that fully engulfs and moves in the opposite direction of the previous candle. - Harami cross candle: has the appearance of a cross with a very little body and often approximately equal top and bottom tails. - Gravestone doji: shows that the price of the stock opened low, it rose in price, but then dropped back and closed fairly near to the open price, its long upper tail indicates possible bearish action. - Dragonfly doji: shows that the price of the stock opened high, it dropped in price, but then increased and closed fairly near to the open price, its long lower tail indicates possible bullish