When markets get choppy and trade in a range, many traders look to profit from shorter-term swings in prices. But how do you know when to buy and sell a stock?
Oscillators are technical indicators that attempt to keep the beat of the market and help traders get in step for shorter-term profits. Oscillators get their name by alternating between low and high with the day-to-day movements of the market. One end of an oscillator’s range represents oversold markets, which according to that indicator have gone down about as much as they typically go in one swing. The other end is overbought territory—where the indicator lingers when the market gets caught up in a buying spree.
The usual way to trade an oscillator is to wait for an oversold condition and buy in as soon as the indicator rises, indicating that market is no longer oversold. Hold the trade until overbought readings register and fade. This plan of attack is often recommended for trading ranges, not trending markets.
For a hypothetical example of how it’s supposed to work, see the chart above. Over this time span, the price (bottom) doesn’t move much. Holding the stock in this time would only have resulted in risk, not profit. But look at what would have happened if trades were based on the Stochastic Oscillator. The indicator is plotted on the top of the chart. Buying when the Stochastic Oscillator crossed upward through the green oversold line and then selling when the Stochastic crossed down from above the red overbought line produced two profitable trades marked by triangles.
Using an oscillator can also turn a losing situation into a gain, as exemplified by AIG over the past five years. During this time, a buy-and-hold investor remained exposed to risk and loss, while the Stochastics trader might have scooped a profit according to the hypothetical backtest results for the period. (See Table 1 – AIG results). Digging deeper trade-by-trade revealed that Stochastics caught two big bear market rallies in AIG that more than offset the limited losses when stopped out on many other attempts.
Moving averages are very important for the knowledgeable investor. It often signifies change of direction either upwards or down wards. When moving average lines cross one another on a chart, it often means either a short term or long term change in direction of the stock price. For those investors interested in swing trading, it could be a very important signal to watch. When moving averages cross paths on a chart, it often signals a trend change. Moving Averages can be calculated from the daily stock trading activity shown on stock charts. Swing traders can use a 10 day moving average (SMA) to enter or exit their positions, some traders also use the 30-day moving average (EMA) to confirm a trend change when it crosses over the 10 day-moving average line.
Stochastic is another tool used by many swing traders. It generally signifies a buy entry or a sell exit point. It is calculated mathematically from two lines, the %K line also referred to as the slow line while the %D line denotes the slow line. Stochastic indicators often alert trades when the markets are either overbought or oversold. Overbought conditions enable traders to short the stock in question while oversold conditions signal a buy entry. It is a very important signal for swing trading. Sometimes there are false crossover signals generated through Stochastic Oscillator, so many swing traders generally wait for a confirmation signal to repeat itself, after which they may buy or sell their positions.
- Try FX Club’s Free Demos
- Learn while practice trading. Try our free demo accounts!
When viewed through stock charts, trading reveals trends over time. This could mean minutes, hours, days, weeks, months or years. Swing traders tend to focus on short term trading opportunities, and they could see such activities in stock charts. Support lines illustrates a range on the chart where a stock price fail to penetrate each time the price trades near that range, swing traders may buy into the market when the stock price enters that zone. Generally, a reversal occurs at that point, and the stock starts advancing. In some cases if the volume is heavy, the stock may break that resistance level, and when it happens swing traders often put in place stop loss orders that will kick in when the set price is breached.
Resistance lines are the opposite of Support lines. They denote trading level where an advancing stock fails to penetrate each time it trades in that zone. Swing traders will sell that stock short when the chart confirms that a resistance point is reached. During the day’s trading activity, a stock with high volatility may have many resistance levels, in some case five or more times. Such conditions means five trading opportunities for swing traders and an opportunity to make money on each occasion.
Double Bottom or Triple Bottom Formations
Stock charts also show swing traders a pattern referred to as double or triple bottom formations. The way these signals are illustrated is very easy to observe. Let’s assume that a stock is declining in value, the first bottom has been established at this point. Suddenly the price reverses direction and starts going back up, only to reverse direction again and start declining once more. When that stock nears the previous bottom, it may reverse direction again, moving up. Short-term swing traders see this as a double bottom formation and may buy into that stock at that point. Sometimes the stock may turn downwards again and may put in place a triple bottom formation. Swing traders usually perceive triple bottom as a more powerful signal.