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Swing Trading For Dummies®

Table of Contents

Introduction

About This Book

Conventions Used in This Book

Foolish Assumptions

How This Book Is Organized

Part I: Getting into the Swing of Things

Part II: Determining Your Entry and Exit Points: Technical Analysis

Part III: Digging Deeper into the Market: Fundamental Analysis

Part IV: Developing and Implementing Your Trading Plan

Part V: The Part of Tens

Icons Used in This Book

Where to Go from Here

Part I: Getting into the Swing of Things

Chapter 1: Swing Trading from A to Z

What Is Swing Trading?

The differences between swing trading and buy-and-hold investing

The differences between swing trading and day trading

What Swing Trading Is to You: Determining Your Time Commitment

Swing trading as your primary source of income

Swing trading to supplement income or improve investment returns

Swing trading just for fun

Sneaking a Peek at the Swing Trader’s Strategic Plan

The “what”: Determining which securities you’ll trade

The “where”: Deciding where you’ll trade

The “when” and the “how”: Choosing your trading style and strategy

Building Your Swing Trading Prowess

Chapter 2: Understanding the Swing Trader’s Two Main Strategies

Strategy and Style: The Swing Trader’s Bio

Two forms of analysis, head to head

Scope approach: Top down or bottom up?

Styles of trading: Discretionary versus mechanical

Wrapping Your Mind around Technical Theory

Understanding how and why technical analysis works

Sizing up the technical advantages and disadvantages

The two main aspects of technical analysis

Appreciating the Value of the Big Picture: Fundamental Theory

Understanding how and why fundamental analysis works

Surveying the fundamental advantages and disadvantages

Looking at catalysts and the great growth/value divide

Chapter 3: Getting Started with Administrative Tasks

Hooking Up with a Broker

Choosing a broker

Opening an account

Selecting Service Providers

Providers to do business with

Providers to avoid

Starting a Trading Journal

Creating a Winning Mindset

Part II: Determining Your Entry and Exit Points: Technical Analysis

Chapter 4: Charting the Market

Nailing Down the Concepts: The Roles of Price and Volume in Charting

Having Fun with Pictures: The Four Main Chart Types

Charts in Action: A Pictorial View of the Security Cycle of Life

The waiting game: Accumulation

The big bang: Expansion

The aftermath: Distribution

The downfall: Contraction

Assessing Trading-Crowd Psychology: Popular Patterns for All Chart Types

The Darvas box: Accumulation in action

Head and shoulders: The top-off

The cup and handle: Your signal to stick around for coffee

Triangles: A fiscal tug of war

Gaps: Your swing trading crystal ball

Letting Special Candlestick Patterns Reveal Trend Changes

Hammer time!

The hanging man (Morbid, I know)

Double vision: Bullish and bearish engulfing patterns

The triple threat: Morning and evening stars

Measuring the Strength of Trends with Trendlines

Uptrend lines: Support for the stubborn bulls

Downtrend lines: Falling resistance

Horizontal lines: Working to both support and resist

Chapter 5: Asking Technical Indicators for Directions

All You Need to Know about Analyzing Indicators Before You Start

You must apply the right type of indicator

Not all price swings are meaningful

Prices don’t reflect volume, so you need to account for it

An indicator’s accuracy isn’t a measure of its value

Two to three indicators are enough

Inputs should always fit your time horizon

Divergences are the strongest signals in technical analysis

Determining Whether a Security Is Trending

Recognizing Major Trending Indicators

The compass of indicators: Directional Movement Index (DMI)

A mean, lean revelation machine: Moving averages

A meeting of the means: MACD

Spotting Major Non-Trending Indicators

Stochastics: A study of change over time

Relative Strength Index (RSI): A comparison of apples and oranges

Combining Technical Indicators with Chart Patterns

Using Technical Indicators to Determine Net Long or Net Short Positioning

Chapter 6: Analyzing Charts to Trade Trends, Ranges, or Both

Trading Trends versus Trading Ranges: A Quick Rundown

Trading on Trends

Finding a strong trend

Knowing when to enter a trend

Managing your risk by setting your exit level

Trading Ranges: Perhaps Stasis Is Bliss?

Finding a security in a strong trading range

Entering on a range and setting your exit level

Comparing Markets to One Another: Intermarket Analysis

Passing the buck: The U.S. dollar

Tracking commodities

Watching how bond price and stock price movements correlate

Putting Securities in a Market Head-to-Head: Relative Strength Analysis

Treating the world as your oyster: The global scope

Holding industry groups to the market standard

Part III: Digging Deeper into the Market: Fundamental Analysis

Chapter 7: Understanding a Company, Inside and Out

Getting Your Hands on a Company’s Financial Statements

What to look for

When to look

Where to look

Assessing a Company’s Financial Statements

Balance sheet

Income statement

Cash flow statement

Not Just Numbers: Qualitative Data

Valuing a Company Based on Data You’ve Gathered

Understanding the two main methods of valuation

Implementing the swing trader’s preferred model

Chapter 8: Finding Companies Based on Their Fundamentals

Seeing the Forest for the Trees: The Top-Down Approach

Sizing up the market

Assessing industry potential

Starting from the Grassroots Level: The Bottom-Up Approach

Using screens to filter information

Assessing your screening results

Deciding Which Approach to Use

Chapter 9: Six Tried-and-True Steps for Analyzing a Company’s Stock

The Six Step Dance: Analyzing a Company

Taking a Company’s Industry into Account

Scoping out markets you’re familiar with

Identifying what type of sector a company is in

Determining a Company’s Financial Stability

Current ratio

Debt to shareholders’ equity ratio

Interest coverage ratio

Looking Back at Historical Earnings and Sales Growth

Understanding Earnings and Sales Expectations

Checking Out the Competition

Valuing a Company’s Shares

Gauging shares’ relative cheapness or expensiveness

Figuring out whether the comparative share-price difference is justified

Part IV: Developing and Implementing Your Trading Plan

Chapter 10: Strengthening Your Defense: Managing Risk

Risk Measurement and Management in a Nutshell

First Things First: Measuring the Riskiness of Stocks before You Buy

Assessing the beta: One security compared to the market

Looking at liquidity: Trade frequency

Sizing up the company: The smaller, the riskier

Avoiding low-priced shares: As simple as it sounds

Limiting Losses at the Individual Stock Level

Figuring out how much you’re willing to lose

Setting your position size

Building a Portfolio with Minimal Risk

Limit all position losses to 7 percent

Diversify your allocations

Combine long and short positions

Planning Your Exit Strategies

Exiting for profitable trades

Exiting based on the passage of time

Exiting based on a stop loss level

Chapter 11: Fine-Tuning Your Entries and Exits

Understanding Market Mechanics

Surveying the Major Order Types

Living life in the fast lane: Market orders

Knowing your boundaries: Limit orders

Calling a halt: Stop orders

Mixing the best of both worlds: Stop limit orders

Placing Orders as a Part-Time Swing Trader

Entering the fray

Exiting to cut your losses

(or make a profit)

Placing Orders if Swing Trading’s Your Full-Time Gig

Considering the best order types for you

Taking advantage of intraday charting to time your entries and exits

Investigating who’s behind the bidding: Nasdaq Level II quotes

Chapter 12: Walking through a Trade, Swing-Style

Step 1: Sizing Up the Market

Looking for short-term trends on the daily chart

Analyzing the weekly chart for longer-term trends

Step 2: Identifying the Top Industry Groups

Step 3: Selecting Promising Candidates

Screening securities

Ranking the filtered securities and assessing chart patterns

Step 4: Determining Position Size

Setting your stop loss level

Limiting your losses to a certain percentage

Step 5: Executing Your Order

Step 6: Recording Your Trade

Step 7: Monitoring Your Shares’ Motion and Exiting When the Time is Right

Step 8: Improving Your Swing Trading Skills

Chapter 13: Evaluating Your Performance

No Additions, No Withdrawals? No Problem!

Comparing Returns over Different Time Periods: Annualizing Returns

Accounting for Deposits and Withdrawals: The Time-Weighted Return Method

Breaking the time period into chunks

Calculating the return for each time period

Chain-linking time period returns to calculate a total return

Comparing Your Returns to an Appropriate Benchmark

Evaluating Your Trading Plan

Part V: The Part of Tens

Chapter 14: Ten Simple Rules for Swing Trading

Trade Your Plan

Follow the Lead of Industry Groups as Well as the Overall Market

Don’t Let Emotions Control Your Trading!

Diversify!

Set Your Risk Level

Set a Profit Target or Technical Exit

Use Limit Orders

Use Stop Loss Orders

Keep a Trading Journal

Have Fun!

Chapter 15: Ten Deadly Sins of Swing Trading

Starting with Too Little Capital

Gambling on Earnings Dates

Speculating on Penny Stocks

Changing Your Trading Destination Midflight

Doubling Down

Swing Trading Option Securities

Thinking You’re Hot Stuff

Concentrating on a Single Sector

Overtrading

Violating Your Trading Plan

Appendix: Resources

Trading ideas: MagicFormulaInvesting.com

Trading software: High Growth Stock Investor

Financial newspaper with stock ideas: Investor’s Business Daily

Charting software: TradeStation

PIMCO’s Bill Gross commentary

Barron’s weekly financial newspaper

Yahoo! Finance portfolio tool

Yahoo! Economic Calendar

Technical Analysis of Stocks & Commodities magazine

The Black Swan: The Impact of the Highly Improbable

Swing Trading For Dummies®

by Omar Bassal, CFA

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About the Author

Omar Bassal, CFA is the head of Asset Management at NBK Capital, the investment arm of the largest and highest rated bank in the Middle East. There, he oversees all asset management activities for institutional and high net worth individuals investing in the equity markets of the Middle East and North Africa (MENA). Prior to joining NBK Capital, Mr. Bassal was a portfolio manager at Azzad Asset Management, where he managed mutual funds and separately managed accounts. Mr. Bassal also worked as an analyst at Profit Investment Management and launched a socially responsible hedge fund in 2002. He holds an MBA with honors in finance, management, and statistics from the Wharton School of Business at the University of Pennsylvania. Additionally, he graduated summa cum laude with a Bachelor’s of Science degree in Economics, also from the Wharton School. He has appeared on CNBC and has contributed articles to Barron’s and Technical Analysis of Stocks & Commodities.

Dedication

To my mother, my mother, and my mother — Maha Al-Hiraki Bassal. To my father, Dr. Aly Bassal. And my sisters, Suzie and Sarah. To my loving wife, Salma, and my brother-in-law, Hisham. And to my beloved nephew, Mostafa. They have always supported me in easy and difficult times.

Author’s Acknowledgments

I don’t believe any experience could possibly have prepared me for the rigorous schedule required to write a book. I can’t tell you how many weekends, evenings, and holidays were required to write Swing Trading For Dummies. The effort was, of course, worth it. But I did miss several episodes of Lost, The Office, and other shows. Alas, the cost of writing books isn’t measured in time alone.

Before I turn this section into an autobiography (which I should pitch to Wiley as my second book, come to think of it: Omar Bassal For Dummies!), let me thank those who deserve thanks (give credit where credit is due, I’m told, is the way the kids are putting it these days). I first learned of this opportunity through Susan Weiner, CFA — a skilled and professional investment writer. Susan told me about a search Wiley was conducting to find an author for this book. Marilyn Allen, my agent, pitched me to Wiley. I’m honored Wiley offered me the opportunity to write this book. Thank you, Stacy Kennedy, for your confidence in me and your buy-in.

Writing the book, as you may have gleaned from my previous comments, was a grueling, tough process, and Kristin DeMint was an invaluable resource. She was my project editor and made sure the book progressed. She often joked that she knew nothing about swing trading. But her “weakness” was in reality a strength. Not being an expert in the subject meant Kristin could offer helpful comments on what might confuse a novice when I made assumptions or didn’t properly explain ideas. Kristin also kept a watchful eye when deadlines approached. Oh how I didn’t want to draw her ire. (I’m half joking. She’s actually a very sweet person . . . as long as I didn’t miss my deadline!)

As my trading mentor, Ian Woodward, once said: Many hands make light work. In addition to Kristin, many Wiley staff members worked behind the scenes. Russell Rhoads, the technical editor, ensured I wasn’t making things up, and other editors — Todd Lothery, Jennifer Tucci, and Elizabeth Rea — made sure my grammar made cents. (They must’ve missed this part!)

Though not involved directly in my project, per se, my family supported me throughout. That meant a lot. It’s not something I can put into words — even as a writer.

Publisher’s Acknowledgments

We’re proud of this book; please send us your comments through our online registration form located at http://dummies.custhelp.com. For other comments, please contact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax 317-572-4002.

Some of the people who helped bring this book to market include the following:

Acquisitions, Editorial, and Media Development

Project Editor: Kristin DeMint

Acquisitions Editor: Stacy Kennedy

Senior Copy Editor: Elizabeth Rea

Copy Editors: Todd Lothery, Jennifer Tucci

Assistant Editor: Erin Calligan Mooney

Technical Editor: Russell Rhoads

Editorial Manager: Michelle Hacker

Editorial Assistants: Joe Niesen, Jennette ElNaggar

Cover Photos: © ACE STOCK LIMITED/ Alamy

Cartoons: Rich Tennant (www.the5thwave.com)

Composition Services

Project Coordinator: Erin Smith

Layout and Graphics: Stacie Brooks, Reuben W. Davis, Nikki Gately, Melissa K. Jester, Christine Williams

Proofreaders: Laura Albert, Context Editorial Services

Indexer: Potomac Indexing, LLC

Publishing and Editorial for Consumer Dummies

Diane Graves Steele, Vice President and Publisher, Consumer Dummies

Kristin Ferguson-Wagstaffe, Product Development Director, Consumer Dummies

Ensley Eikenburg, Associate Publisher, Travel

Kelly Regan, Editorial Director, Travel

Publishing for Technology Dummies

Andy Cummings, Vice President and Publisher, Dummies Technology/General User

Composition Services

Gerry Fahey, Vice President of Production Services

Debbie Stailey, Director of Composition Services

Introduction

I wish I could tell you that swing trading is fast and easy and leads to overnight profits that will make you an instant millionaire. Just buy my five CDs today to discover how you can swing trade to massive riches! Or attend one of my training conferences coming soon to a hotel near you: “How I Swing Trade in My Bathing Suit!” (Film cuts to a testimonial from an “actual” client wearing a Hawaiian T-shirt: “I’ve tried the Omar Bassal Swing Trading Technique [this is patented, of course] and I made more than $5,000 on one trade alone!”)

Okay, back to reality. Swing trading isn’t going to lead to overnight wealth. Period. Anyone who tells you different is either lying or has made an incredibly risky trade that turned out positive by the grace of God. You can go to Las Vegas and bet $10,000 on the color black at the roulette table and possibly double your money (your odds are slightly less than 50 percent). But is that a sound plan?

Of course not. And it’s no different when it comes to swing trading.

At best, as a novice swing trader, you’ll produce market returns in line or slightly above the overall market. If you’re really besting the markets, it may be because you’re taking an inordinate amount of risk that may eventually wipe away your account assets. And even as a stellar swing trader, expect to produce returns of 20 percent or possibly 30 percent annually. (If you want quick profits, first make sure you’re an impeccable market timer, and then look into day trading.)

Unlike day traders, swing traders hold positions over several days and sometimes for a few weeks. But similar to day traders, swing traders rely heavily on signals from chart patterns and technical indicators to time their entries and exits from securities. The goal of swing trading is to profit from short but powerful moves on the long side (buying) and short side (selling) of the stock market.

Swing trading also differs from the buy-and-hold approach to investing. Long-term investors may hold a security through periods of weakness that may last several weeks or months, figuring that the tide will eventually turn and their investment thesis will be proven correct. Swing traders don’t care for such poor performance in the near term. If a security’s price is performing poorly, swing traders exit first and ask questions later. They’re nimble and judicious in choosing potential opportunities.

About This Book

In Swing Trading For Dummies, I introduce you to the strategies and techniques of the swing trader. Moreover, I cover topics given short shrift in some trading textbooks — topics that largely determine your swing trading success. For example, whereas many textbooks focus on chart patterns and technical indicators used in buying or shorting stocks, this book goes one step further to cover the importance of money management, journal keeping, and strategy planning. Although these subjects are less glamorous than looking at charts, they’re actually more important — because even exceedingly skilled chart readers will fail if they devise a flawed system, take unnecessary risks, and don’t learn from their mistakes.

Here are some of the subjects this book covers:

Calculating investment returns: This is one of those unglamorous topics, but if you don’t properly calculate your returns, you’ll never know whether you’re doing any better than the overall market. The process is simple if you’re not adding or taking away funds from your account, but the procedure can get more complex if you frequently withdraw or add funds.

Keeping a journal: The word journal seems to be a lot less offensive to people’s sensibilities than diary. A journal is like a trading coach, telling you what you did wrong or right in past trades and helping you to avoid repeating mistakes you made previously. Just knowing the symbol, price, and date of your trades isn’t going to cut it. This book shows you the key features of a valuable trading journal.

Managing your risk: The most important chapter in Swing Trading For Dummies is Chapter 10, where I explain how to manage your portfolio’s risk. As remarkable as this may sound, even if you get everything wrong except your risk management, you can still make a profit. Van K. Tharp, a trading coach, once said that even a totally random entry system can be profitable if your risk management system is sound.

Focusing on fundamentals: This book differs from other swing trading books in its emphasis on the fundamentals of securities. All too often, swing traders pay attention only to the chart and disregard the company behind the chart. You don’t need to spend 20 hours a day analyzing a company’s financial statements — swing traders don’t have that kind of time on their hands. But it’s essential to find out the basics and apply the most important measures in your trading.

Paying attention to the popular (and easy) chart patterns to trade: Dozens of chart patterns appear from time to time in securities’ price patterns, but not all of them are sound or based on investor psychology. That’s why I focus on the tried-and-true chart patterns to give you the critical ones to look for.

Outlining your swing trading plan: A trading plan must outline when you’re in the market and when you’re not. It must detail your criteria for entering and exiting securities. Your plan should also cover what to do when a trade doesn’t work out, as well as how much you risk and how you handle your profits.

Conventions Used in This Book

I use the following conventions to assist you in reading this text:

Bold terms are for emphasis or to highlight text appearing in bullet point format.

Italics are used to identify new terms that you may not be familiar with. I also use italics to highlight a difference between two approaches (for example, higher than the first case).

Monofont is used as text for Web sites.

Charts and figures used in this book have text next to them explaining the essential point the figure conveys. These captions make it easy to skip to different charts and take away the critical point made in each one.

Foolish Assumptions

I made several assumptions about you when I was writing this book. I’m assuming that you

Know how to trade securities online

Plan on trading stocks or exchange traded funds

Have little or no experience swing trading but are well versed in the basics of trading in general

Are able to access and use Internet Web sites that cover research, charting, news, and your portfolio account

Have the will to change your current trading approach

Don’t have an MBA, CFA charter, or CMT designation and need some terms and techniques explained clearly

Aren’t a genius and don’t think of yourself as the character Matt Damon plays in Good Will Hunting

Appreciate humor and popular movie references

If you want to trade other types of securities — like currencies or commodities — you may want to pick up Currency Trading For Dummies by Mark Galant and Brian Dolan, or Commodities For Dummies by Amine Bouchentouf (both published by Wiley).

How This Book Is Organized

This book has five main parts. You may not need to start at Part I and proceed from there. You may be better served beginning at Part II or Part III if you already know the basics of swing trading.

For that reason, I explain the five parts as follows so you can determine which part or parts you need to focus on.

Part I: Getting into the Swing of Things

Swing trading can be a rewarding endeavor for those who have the time and interest in trading securities over the short term. But you need to pack your backpack before you set out on the journey. Part I helps you do just that. This part introduces you to swing trading and provides an overview of the investment landscape. You also discover the brokers that cater to swing trading and the two main trading strategies (fundamental analysis and technical analysis).

Part II: Determining Your Entry and Exit Points: Technical Analysis

Swing traders rely heavily on technical analysis: the art and science of trading securities based on chart patterns and technical indicators. But it’s easy to get lost in the world of technical analysis given how many different chart patterns and indicators exist. When should you use this indicator over that one? Part II explains the ins and outs of technical analysis for everyone from the neophyte to the market expert.

Part III: Digging Deeper into the Market: Fundamental Analysis

Fundamental analysis is given short shrift in most swing trading books, but I introduce you to the important fundamental measures you may be overlooking. Fundamental analysis doesn’t have to be a scary science that only institutions use to their advantage. You, too, can profit from simple fundamental ratios and measures. In this part, I cover the basics of financial statements and the criteria you can use to screen for under- or overvalued stocks.

Part IV: Developing and Implementing Your Trading Plan

Your trading plan is your map in the swing trading world — or your GPS, if you prefer to have directions read to you. Your trading plan outlines what you trade, how often you trade, how many positions you own, and so on. In creating your plan, you must decide how much to risk on each position and when to exit (for a profit or a loss). You also need to know how to calculate your performance so you can tell whether you’re ahead or behind the overall market.

Part V: The Part of Tens

The Part of Tens includes “Ten Simple Rules for Swing Trading.” Stick to these rules and you’re unlikely to make any major mistakes that take you out of the game. But you need to know more than what to do; you must also know what to avoid at all costs. “Ten Deadly Sins of Swing Trading” covers ten “sins” that are sure to lead to subpar performance. Maybe not today or tomorrow, but eventually, these sins will catch up with you.

And what would a book be without an appendix? In this book’s appendix, I recommend several valuable resources you should use to help you with your swing trading.

Icons Used in This Book

I use icons throughout the book to highlight certain points. Here’s what each one means:

Remember.eps This may be somewhat self-explanatory, but the Remember icon references subject matter you should remember when swing trading. Often, the Remember icon highlights a nuance that may not be apparent at first glance.

warning(bomb).eps I don’t use the Warning icon often, but when you see it, take heed. As a swing trader, you must always take action to ensure you’re able to swing trade another day. I use this icon to point out subject matter that, if ignored, can be hazardous to your financial health.

traderssecret.eps The Trader’s Secret icon signals that the material presented is quite technical in nature. Most often, the technical tidbits are my own personal insights based on experience.

Tip.eps A Tip icon marks advice on making your life easier as a swing trader. If Swing Trading For Dummies were a second grade classroom, this icon would signal my jumping to the end of the fairy tale Goldilocks and the Three Bears and telling you how it ends. The Tip icon cuts through the fluff and tells you exactly what you need to know.

Where to Go from Here

Like all For Dummies books, this book is modular in format. That means you can skip around to different chapters and focus on what’s most relevant to you. Here’s my recommendation on how best to use this book depending on your skill level:

For a newcomer to swing trading: I strongly encourage you to begin with Part I and proceed to Parts II and IV. You can skip Part III if you plan on exclusively using technical analysis in your swing trading.

For the swing trader looking to refine his or her skills: Parts III and IV will likely be of most value to you because you probably already have a good bit of technical analysis under your belt. Help in designing your trading plan, which I cover in Part IV, may be the best way to improve your results. Remember, Chapter 10 is the most important chapter in this book.

For the swing trading expert: You may benefit most by using this book to target specific areas for improvement. The index or table of contents can help you identify which parts of the book to target.

Part I

Getting into the Swing of Things

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In this part . . .

If you’re just embarking on your swing trading journey, then this is the part for you. In the next few chapters, I help you figure out how much time you’re willing to devote to swing trading and clue you in to the lingo you need to know. I also introduce you to the rules of the swing trading game, the steps you can take to get ready to play, and some recommended strategies for growing your portfolio into a swing trading success story.