If there’s anything that the modern stock market has taught us, it’s that it’s no longer a matter of slow and steady wins the race. Sure, that long-term strategy exists, but as the proliferation of short-term strategies and day trading has demonstrated, armchair investors that do nothing more than read charts in front of their home computers don’t have to wait for an extended period to cash in on a prime payoff. Swing trading is a strategy that seems custom-made for those that for this next breed of investor; the one that doesn’t have time or patience to wait for a stock to grow in anything that remotely looks long term. Fortunately for them, plenty of indicators exist to help them turn swing trading into a bona fide strategy instead of a guessing game.
There is Math Involved
To the uninitiated, it may appear that practitioners of swing trading go about their business pretty effortlessly; that they sit around, analyze charts, and read patterns to make the right decision more often than not. Yes, they do use technical indicators to help steer them in the right direction. But there is a fine art to deciphering these charts in a way that goes well beyond a line moving up or down. This technique incorporates mathematical formulas and tools that help them ascertain useable information.
These math-based tools are known as indicators, and they can help these short-term speculators transform what may look like a game of luck into a game of skill (at least, a game of skill that still contains risk). Granted, even though there is hardline mathematics at play here, a certain level of finesse regarding knowing how to use the math is necessary for success. Still, these indicators can be utilized by the swing trader to extract information from the charts that minimize their seemingly arbitrary nature.
Common Swing Trading Indicators
One of the leading indicators used by swing traders is on-balance volume. This indicator aims to supposedly determine a link between a stock’s price and the number of shares traded. Its theory is uncomplicated: if a significantly greater number of stock units are being purchased compared to another period, yet if the stock price is in a holding pattern, the stock price is destined to shoot up to match the increased volume. It creates a pretty simple formula. If a price rises when an on-balance volume falls, it’s time to buy. If a price falls while the on-balance volume increases, it’s time to sell. When the two figures move in the same direction, do neither.
Another indicator that’s used is known as the price rate of change. This tool cajoles the investor to look at recent closing prices relating to older ones. This is not as simple as on-balance volume because the math required is a bit more complicated. Let’s say you’re looking at a stock whose closing price lands at $24. Now, subtract that number from the closing price of the stock three days ago; in this hypothetical, let’s say the number was $20. Divide that number ($4 if you’re keeping score at home) by the old closing price. That gets you a rounded number of .17, which is known as the price rate of change. To the swing trader, this figure represents the strength of an upward or downward trend. The further that number is from zero, the stronger the trend is said to be. If the resultant price rate of change is positive, it's buying time. If it’s negative, then it’s time to sell.
Arguably the most elaborate indicator is known as the commodity channel index. This serious-sounding indicator calculates excess deviation from the established norm. Again, there is math involved, and this one’s a little more tough to wrap your head around. The indicator starts by taking the stock’s “typical price,” which is a figure derived from averaging its high, its low, and its close over some period. For instance, if you have a stock that opens at $20, jumps up to $28, hits a low of $19, then hits $25 at the closing bell, the “typical price” of that stock would be $24.
Once that number’s established, the investor will subtract the simple moving average over the same period, which is the average of the stock’s daily closing prices. For instance, if the stock’s closing numbers over a five-day period were $21, $19, $23, $27, and $25, the simple moving average is $23. When subtracted from the typical price, the investor is left with $1.
After this, the investor calculates the mean absolute deviation. To do this, the investor will start with the typical price in a given period, compare each number to the typical average price, and subtract the lesser from, the greater. Then, they would divide that number by the number of sessions. In the example above, the number of sessions would be five days. When that number is calculated, divide that into the difference between the standard price and the simple moving average, and then multiply it by a constant of 66 2/3. The result of this complicated formula is a quantity that should tell you not only when the prices will change, but when they are reaching their highest peak or their lowest valley, and at what strength.
What Do These Indicators Mean?
No matter how simple or complex some of these indicators appear to be, the bottom line is that they all exist to help the swing trader maximize profits while minimizing the risks that are inherently part of the stock market. This endgame is no different than any other financial strategy, even if the participants involved in deploying this strategy don’t appear to be going about the business of stock market trading like the traditional investor might. And really, who cares if they don’t necessarily look the part of an investor? Based on the amount of mathematics that is typically involved in correctly using these indicators, they can’t accurately be accused of being slackers.