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Swing Trading in a Fundamental Minefield

3 November 2014 No Comment

Swing trading strategies have taken on a whole new meaning in the last few weeks as fears of an exit from stimulus give traders pause for caution. Just as quickly as the VIX volatility index soared on the shift in sentiment towards pessimism, it managed to shift back towards full-blown market optimism as the ECB unveiled its own quantitative easing program. Market conditions are back to resembling features of the lead up to the “great recession” as traders reposition for a market that will see diminished Central Bank support.

From a technical trading perspective, market corrections always come swifter than the prevailing move. If the market is at the beginning stages of a correction or even a shift towards a near-term bear market, expect choppiness to ensue and volatility measures to gain. Just remember, it is important not to fight the trend. Swing trading as a strategy is formulated on a multi-day outlook, not an intraday scalp, so be sure to identify the trend in different time periods that are reflective of the expected trade time horizon.

Timing the Market Effectively

Buy the dip has been a common trading strategy since 2009, but is gradually losing its shine has the Fed proposes to yank the training wheels by the end of this month. While traders with strong stomach were largely rewarded by this strategy in the latest dip, it is a strategy that works until it does not. If indeed the market top was put in the other month, this could spell pain if risk limits are not carefully planned and game plans are not disciplined.

The difficulty facing most traders is identifying solid confirmation of the market being oversold or overbought as these are typically the best situations to employ swing trading strategies. Catching the falling knife is every trader’s dream, but cutting one’s hand open is the likely outcome without proper discipline and strong corroboration that a reversal is in progress. Many traders turn to the RSI and other technical indicators to successfully identify entry and exit points for swing trading strategies.

Combining Indicators to Identify Entry and Exit Points

The RSI or relative strength indicator is an effective tool for understanding momentum and helping define entry points for swing trades. In conjunction with momentum indicators like the MACD (moving average convergence-divergence), adding a short-term moving average to the mix can help provide more evidence of a short-term trend direction. Momentum is often treated as a leading indicator, with prices reversals preceded by momentum changing direction after sharp gains.

A recent example of an effective setup identified by the RSI and MACD signaling a buy opportunity was the oversold the dip in Gold witnessed earlier in the month. On a two hour chart, the RSI reversed from below the 20 line on October 5th and the MACD saw the histogram make 3 consecutive positive bars signaling a change in momentum with the cross moving average lines. Traders who bought the bottom effective could have seen over $50 points of gains.

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Do Not Fight Market Fundamentals When Using Swing Trading Strategies

It is important to know that there can be conflict between technical analysis and the fundamental outlook in certain setups. Once such example where the technicals are screaming overbought and momentum indicators are pointing upwards is the U.S. Dollar versus the Russian Ruble (USD/RUB). This particular example is relevant because the RSI is above 80, an area that would typically indicate a place to sell the pair. The MACD is also signaling upside bias with the moving averages notably above the zero line. If the RSI reverses and the shorter term MACD moving average crosses the longer to the downside this could signal a great entry point with the elevated RSI. The risk is fundamental in that continued conflict between Russia and Ukraine threatens further harm to the Russian economy, possibly leading to further devaluation of the Ruble.

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Even if both indicators are signaling a direction, it is important not to neglect identifying projected risk and reward of a swing trading opportunity. If trading indicators were correct 100% of the time every trader would use them and generate returns. However, in the absence of certainty, employing a game plan with carefully designed entry and exit points is a way to mitigate the risk of receiving an inaccurate signal. Having familiarity with upcoming fundamental announcements is important for understanding any event that may impact a trade over the projected trade time horizon.

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