Swing Trade Setups Part 5: Indicators

 [ This is the 5th article in a series, describing how I trade.  You can start with Part 1 here ]

This is the 5th Part of a 6 part series outlining the how I analyze potential positive swing trade reversal patterns.

So far, we’ve covered:

  1. Looked at the basic structure of the previous upswing and the down-swing that we think will reverse
  2. Added moving averages to the mix
  3. Determined support and trend-lines
  4. Added candlestick signals

Now I’d like add an additional 5th layer to the mix…indicators.  Indicators do much of the heavy lifting when it comes to identifying swing trade candidates. Just like moving averages and candlestick signals, they are very easy to add to a screen calculation that then spits out the results to review.

I use indicators as the final deciding factor whether I should enter a potential trade or not 

The question is…what indicator should be used.  Well, you can use whatever the heck you want!  I would use what has been working for you in the past, which is likely what you are most comfortable with.  After all, if you end up going with something that doesn’t “speak” to you, then the results will normally never work because it doesn’t align with you.  The key is to have a trading system that fits you.

However, if you find that there is room for improving your trading results, it is worth it to always try new methods and techniques.  After all, there is always room for improvement right?

Also, you should understand what an indicator is telling you and understand how it is calculated!  After all, when you think about it, all indicators use the SAME set of data: price, volume and time.  What else is there, really.  When you think of the massive array of indicators, it’s amazing to think that they all derive their results from such simple, fundamental data.  That is why I feel it’s important to lay a pair of eyes on the actual chart (as we have done) and make the determination whether a trade has potential or not.

Indicators have some flaws that can really screw with a trader. 

  • Many typically lag price, so by the time they flash their signal, the price has moved out of the ideal buy or sell range.
  • They can “wag the dog” making a trader feel that they are the end all, be all.  Indicators should be one piece of the puzzle, to provide a “weight of evidence” to support or deny whether one should buy or sell.

And here is another BIGGIE to chew on: Have you ever wondered if different indicators that you have used are telling you the same thing?!  You might be using 3 or 4 indicators that are all on one side of the boat….rowing.  All of them might be screaming buy.  Or all of them might be screaming sell.  What if they all were basically the same?!  That is a problem.

Just as they say that one of the basics of finance is diversification…what if you haven’t diversified your indicators?!  You want to know that the indicators you are using are producing signals that come from angles.  It’s good to look at a potential trade from different angles and it is wise to make sure that the indicators that you have chosen are doing the same things.  It is good to classify indicators into major categories and then pick one from each group.

Here are a few of the major indicators that I have classified into groups:

Trend indicators:  

  • Moving averages
  • MACD
  • Parabolic SAR
  • Average Directional Index
  • Linear Regression

Momentum indicators:

  • RSI
  • Stochastics
  • CCI
  • Chande’s Momentum Oscillator
  • Williams % R

Volatility (Volume indicators):

  • Bollinger Bands
  • Envelopes
  • Chaikin’s Volatility
  • Average True Range
  • Volatility Channels Indicator
  • Projection Oscillator

Volume Indicators:

  • On Balance Volume
  • Chaikin’s Money Flow Index
  • Ease of Movement
  • Force Index

Take a look at the indicators you use and see if you are using several that fall into the same category.  You don’t want to end up with several indicators telling you the same thing.  That will give you false confidence!  I’ve certainly done that…for years actually.  I was using indicators that we telling me the same damn thing.  What’s the point of that?

Ok, let’s get on with it and take a look at AAPL and ON again, and add indicators to the mix:

Here is the chart of AAPL with 2 indicators that I typically use, RSI and MACD:

Notice how these two indicators, RSI and MACD come from momentum and trend groupings.  They are NOT related to each other.  However, you can see that they are both flashing “buy” here.

I’ve highlighted two timeframes in a light green bar:

  1. The one on the right is where I was trying to decide whether to enter APPL for a swing trade.
  2. The one on the left is what I had been looking at before when I scanned the chart for examples of how AAPL reacted in the past when the indicators were basically at the same point as the present.

First, with RSI, notice how it didn’t reach the oversold range of 30 until the very bottom of the move down.  If you had tried to buy during the downtrend, looking for a swing up, you would have been roasted.  The RSI was telling us not to buy.  At the range of 30, the momentum is changing from down and signalling that an upswing is becoming likely.

Next, look at the MACD along the bottom.  I mostly pay attention to the blue bars, which are plotting the difference between the 2 moving averages.  When you see the bars start to flatten, and then start to move back upwards to the Zero (0) line, you know the trend is starting to reverse.  I typically don’t wait for time (days) to pass by and enter when the MACD bars get to that Zero line.  I can tell that the writing is on the wall already…the move up is starting!

Now I’m going to layer in another indicator that I love, Bollinger Bands…from the volatility category.  Take a look at AAPL again, this time with Bollinger Bands on the chart:

Here is the same timeframe chart for AAPL, but only Bollinger Bands.  First of all, just because a price hits the bottom band, does not automatically mean that you should buy.  Look at what happened if you did that!  The price during both down-swings ended up “walking the bands” down, sticking to the lower band like white on rice!  But at our trusty turning points, you can see what starts to happen…the band starts to flatten a bit, and the price is now starting to trade sideways, inside of the band (BLUE arrows).

It is at this point that the Bollinger Bands are telling us that the downside volatility has ended and we are at a relative low.  The trend is likely up from that point.  That is exactly what happened, as you can see that the price bounced from the previous low that I had used as a data point from past history (the left BLUE arrow), and ended up happening with the actual trade I took on the right (the right BLUE arrow).

Ok, now let’s take a look at ON with the same indicators:

This chart of ON is almost exactly the same as AAPL, right?  The RSI is at a low point and the MACD is starting to turn upwards.  Notice one difference though.  The RSI never quite touches the oversold line of 30, like it did with APPL, does it?  Why is that?  I don’t exactly know.  That is why I like to look to the left of the chart (in the past) and see how this stock behaved in the past to any prior downturns.  You could see that the RSI never hit 30 on the left, did it?  If I had waited to only enter if it hit 30 when I was trying to decide whether to enter the trade, I would never have entered!

That brings up another point: Swing trading…and trading in general, is both an art and a science.  it takes time to get a feel for what is the best thing to do.  Rigidly following a trading formula might work for some (and it does work), but it’s not for me.  I like to combine a relatively rigid system (my screens) which gives me potential swing trade candidates, but then use my eyes to look at the charts to the screen results and scan them for what I feel is the best trading opportunity.

Ok, I almost forget…here is the Bollinger Band overlay on ON:

You can see that this chart is a nice closeup of each of the two areas of interest: the BLUE arrow is what I was looking at before I entered the trade on the right BLUE arrow.  You can see that each time, the stock started to trade inside the lower Bollinger Band and then moved higher, towards the middle.


What I love about Bollinger Bands, is the fact that they are telling us on a relative basis, whether a stock is at a low or not.  Using the bands keeps me from catching a falling knife.  They give you perspective about whether we have reached an ebb in the downside volatility and the likelihood that the move is reaching a stopping point before heading in the opposite direction: UP.

I have written a detailed post specifically about how I use Bollinger Bands for swing trading here.

Up next: Setting up Stock Screen Filters

  • Before moving to the next step, sign up for my email list. [Opens new browser]
  • I’ll send you the password to a page that contains the top free tools I use every single day to find the best stocks to trade.

Swing Trade Setups Part 6: How to Setup Stock Screens, which outlines how I find potential swing trade reversal candidates using stock filtering websites.

The Greedy Goblin

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