This is an exclusive extract from Michael Thomsett’s new book, Options for Swing Trading. We’ll be running extracts from Michael’s book all throughout November and you can even win yourself a copy by entering our competition here, or read on below for details on how to claim 30% discount through Littlefish FX.
Part 5: Swing Trading Basics
The study of price patterns and momentum is essential to the improved timing of entry and exit. That’s the goal of swing trading: improving the timing. No one can promise a system to deliver 100% perfect timing. However, spotting reversal relies on pattern analysis and confirmation.
Swing trading in its most basic form depends on three types of reversal signals. These are:
1. Narrow-range day (NRD) . The NRD, known among candlestick chartists as the doji, is a session in which the opening and closing prices are identical or very close. Such a day may have trading ranges both above and below, but the fact that price opens and closes at the same level is viewed by swing traders as very significant and as a likely signal of reversal.
2. Reversal day. A short-term trend, by definition, consists of three or more sessions moving in the same direction. Second, each session in an uptrend should open higher than the previous session and should also close higher. In a downtrend, each session should open lower and also close lower than on the previous day. Given these definitions, a reversal day is a session moving in a direction opposite to the short-term trend. This often marks the end of the trend and is the first sign of a reversal.
3. Volume spike. In addition to the all-important NRD and reversal days, swing traders place importance on volume spikes. These are sudden exceptionally high-volume days in comparison to preceding sessions; by definition, a spike requires that volumes return to previous levels. High volume indicates higher than average interest among traders, and when that high volume shows up at the same time as other reversal signs, it increases the likelihood that a reversal is about to occur.
These basic signals are only the starting points for swing trade analysis. Beyond these, it makes sense to rely on traditional charting analysis. . Traditionally, stock-based technical analysis focused mainly on chart reading, and options-based technical analysis focused exclusively on implied volatility (usually through study of changes in delta, gamma, and the other “Greeks”).
In the chart-based approach to using options in swing trading, both of these are combined. Charts are studied using four primary methods: price analysis through candlesticks, price patterns found in Western technical analysis, volume indicators, and momentum oscillators. All four add insight to trends and help to spot reversals; however, when these are used to spot and confirm reversals as part of timing for options positions, timing will be improved and as a result the swing trade success rate will increase.
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