Here are some tools and tactics swing traders can use to determine when it is time to starting swing trading on the long side again.
The major indexes have fallen this week, with the S&P 500 off its Feb. 19 high by about 6% in morning trading on Feb. 25.
I am trader. Any analysis I do on the indexes is not meant to forecast the market per se, but rather give myself a framework of when it is a better time to start looking for long swing trades. I don’t usually consider short trades unless things really start deteriorating. 5%, even 10%, declines in the S&P 500 aren’t enough to tweak my interest in taking shorts. I would rather monitor the stocks that are strong so I have a list to trade when the market stabilizes and starts to rise.
I use a couple tools to aid in this, but mainly I rely on my scanners.
I scan for strong stocks, and typically this includes parameters like: stock is within 10/15% of its high, stock is above 100- and 200-day moving, and then maybe a performance metric, like 1-month return is greater than 3%.
When the market is rising, a simple scan like this will produce loads of stocks.
Once the S&P starts declining more than 5% from its high, the number starts to dwindle. As you may know, I like to trade stocks that break out of small consolidations. So even when there are stocks on the scanner list, typically they are starting to drop, and not move higher out of consolidations which is what I am looking for. Basically, the number of quality trading opportunities drops…often to zero.
So basically my scanner keeps me out until things start to improve. As things improve, more stocks show up on the list, and more stocks have the correct setup within that list.
Other Tools for Determining When It is a Good to Buy Stocks
As the indexes are in decline, we want to look for some stabilization or a bounce. There is no real reason to buy when stocks are in free-fall. Any quality swing trade setups we do see are more likely to fail when the market is falling (or even oscillating around and not rising).
One of the main indicators I look at is the NYSE advance-decline line (!ADLINENYA on stockcharts.com, also called the AD line). If that indicator is falling, it means more stocks are declining than advancing. That is not a favorable time to be trading stocks. You want more stocks advancing (if going long), as the odds are more in your favor of picking a winner, even if it is totally random or done without skill.
So I will watch for a rising AD line, or will watch for it to break above a recent high or pullback high…like when it moves above the horizontal lines examples I have drawn on the indicator.
You can also monitor how many stocks are above their 50-day moving average For this I use $SPXA50R on stockcharts.com. It shows how many S&P 500 stocks are above their 50-day moving average. When the market is rising, that number spends a lot of time above 60%. When the market declines, it drops below 50%. I like to look at that 50% level. Below that, the odds aren’t in our favor for being long. Above 50%, more stocks are exhibiting a short-term uptrend, so that is a more favorable time. Above 60% is better.
There loads of indicators like this. Pick ones that work for you.
Neither of these indicators are perfect, nor do they tell us exactly when to trade and when not to. Yet all this information discussed so far gives us a pretty good guide!
- If the stock index, AD Line, and A50R are dropping (especially below 50 for A50R) it is not a good time to buy stocks.
- As the stock index, AD line, and A50R rise (especially above 50 and 60 for A50R) it is a better time to trade those high-quality stocks on the scanner list.
- As the indexes and indicators rise, more stocks will start appearing on the scanner list. More quality setups will be visible within that list. If 2 is true, it is now acceptable to start taking those quality setups as they trigger.
So Where is the Market Going Next?
I could put some figures based on historical statistics, but ultimately, as swing traders, we don’t really need to do that.
As a swing trader, I want favorable conditions to develop for buying stocks. It is easier to make money when the index and AD line are rising. It also helps when more stocks than not are above their 50-day moving average, as it shows there is at least some short-term strength in the market.
I then use my strategies to enter stocks that are strong and moving well.
There is no need to guess when the market will bottom. We can wait for the signals (2 and 3 in the list above) to say it is ok to start buying swing trade stocks again. This is the concept discussed in AnticipateWhere Price Will Be to Become a Better Trader. If you wait for the “go” signals from the indicators, and you have also been tracking a few high-quality setups in your scanner, you will know exactly what and where you will be buying (and placing your stop loss) before that trade occurs. You will be ready, with a plan.
By Cory Mitchell, CMT, join me on Twitter @corymitc.
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, or even more than you deposited if using leverage.