Swing theory and swing charts in technical analysis are theory around charts that belongs to the technical analysis family of “reversal charts”. The most frequently used type of swing chart is the Point and Figure (P&F) chart, which is said to have been invented in the late nineteenth century by the legendary trader James Keene.
We can define a reversal chart as any chart that filters the raw price data to highlight only the important price points. It is common knowledge in the technical analysis community that valleys and peaks are of most interest whereas sideways movements in the market don’t provide much information, and therefore are not as interesting.
Bottoms and peaks are those points of the price action where the direction reverses and the slope of the existing trend changes its arithmetic sign. Below I will use the original terminology from Ralph Elliott to avoid potential confusion with other technical analysts.
A wave is a single straight diagonal line on a chart. Waves always have slope, i.e. they are never parallel to any of the axis in the chart.
A peak is a point of intersection between an upwards sloping wave on the left and a downwards sloping wave on the right, i.e. this is a local maximum for the price.
A valley is the point of intersection between a downwards sloping wave on the left and an upwards sloping wave on the right, i.e. this is a local minimum for the price.
A cycle is just a series of interconnecting waves which will invariable have peaks and valleys in between.
In order to draw and Point and Figure chart we then need determine one key additional input: the box size.
The most freԛuently used box size in swing theory is the minimum price amount in which the currency can change. In Forex markets this is a pip. There are three cases where the box size can be greater than one pip.
First, this is when the parity rate between the two currencies causes a large bid-offer spread. For example for the EURCZK pair the bid-ask can be 350 koruny, meaning one pip has no filtering meaning.
Second, in swing charts a larger box size can be used when analysing historical data on a longer timeframe. In this case, the trader would be looking for major price movements rather than intra-day trend reversals.
Lastly, swing chartists can choose to use a larger box size to align peaks and valleys on a chart but this is a personal preference.
There are a number of other inputs that need to be set when applying swing theory such as the reversal amount. There is are a number of free websites offering great information on swing charts and I strongly encourage you to have a look at them. They can make the difference between you achieving wealth trading Forex or not.
If you want a simple to understand and easy to apply Forex trading strategy which makes big gains, you should try using a Forex swing trading strategy.
Before we look at the strategy, let’s take a look at the logic upon which swing trading is based. Swing trading is based on the simple concept that traders are emotional and will push prices to far to the upside when greed is present and to far to the downside when fear is present and you will see short term price spikes on any currency chart when this occurs.
These price spikes never last long and prices soon return to fair value and the aim of the swing trader is simple – sell into greed and buy into fear and make a profit as prices return to more realistic levels – that’s the theory, now we need to look at a trading method to make profits from these price spikes.
Below we will outline a simple strategy you can use and we will look at it from the point of view of making money from a price spike that to the upside but the same logic will also work in a bear market – here’s the strategy.
• Look for a short term price spike to occur on a chart and then, check to how overbought the currency is in historical terms.
• To measure how overbought prices are, you can use some momentum indicators and there are many to choose from however the best in my view are the stochastic, the RSI and the MACD. These indicators are easy to learn and will show you how overbought the currency is in historical terms. If the indicator is overbought, you need to wait for the trading signal to be generated.
• To generate your trading signal, wait for momentum to fall as prices are still moving to the upside – this is known as divergence and warns that a prices will fall so you go short.
• Your stop is placed immediately, above nearby resistance and you then need to set a target which should be just above, the level of support you think prices will pull back too. You shouldn’t wait for support to be tested just in case of a rebound, take your profit early, get out the market and wait for the next opportunity.
• When swing trading always remember the bigger the price spike and the more overbought the market is, the better the opportunity will be be, in terms of profit potential so only trade extreme moves.