Swing Trade Setups Part 7 – Putting it all together

So far I’ve highlighted the major steps in my process for identifying awesome swing trading opportunities.  We’ve covered quite a bit!

But I haven’t talked yet about the most important parts of how I trade….discipline.

Yep, discipline.

Pretty boring, I would probably agree.  But in my opinion, everything I covered so far pales in comparison to how important this is.  I credit discipline to be the real key…the secret to how I’ve become successful as a swing trader.

I’ve suffered through many years of losses.  I’ve taken my trading accounts from a few thousand dollars and came within a few good few trades away from pushing it to 6 figures, only go have those trades completely wipe out my account.

I was trading in a way that didn’t fit my personality and lifestyle.

I was picking trades simply because I came across a random chart, thought it looked good and jumped on it.  I was a mess. I didn’t have any disciple. 

  • No trading plan. 
  • No risk management. 

Sometimes I was successful trading, but in the end, I was always undone by my lack of discipline.  It wasn’t until I decided to put an end once and for all to free-wheeling trading style that I finally turned the corner towards long-term profitability.

Here’s what I’ve covered so far about how I trade:

  • Describing my ideal trading setup(s) – You’ve read through the earlier parts of “How I trade”…that’s my outline of the types of trades that I am looking for. You have to do that.  There has to be a type of typical trade that you know, and understand inside and out!  That’s discipline.
  • Stock screens/filters – take your ideal trading setup that you have outlined, and translate it into a series of stock screening filters. This might take time…a long time.  Some of my screens to months to create.  I tweaked and backtested unit I was comfortable that I had something.  That’s discipline.
  • Limiting your options – I only review the stocks that show up on my stock screens for trading opportunities. Don’t get sidetracked.  Don’t trade any chart that shows up outside of your screen that you come across, no matter how good it looks.  You make one exception and then next thing you know, you are off the rails again.  After all, why would you want to look anywhere else?  The stocks that show up on your screen results are the best of the best.  The highest potential to match exactly what you are looking for!  That’s discipline.

All of that stuff is great…and important.

But the most important part of how I trade is the discipline to determine my profit and loss potential before I even enter a trade.

I might have found what looks to be a promising chart that showed up on my screen.  Everything seems to check out.  But before I enter a trade, I want to set how high I expect the swing trade to go and how low it might go.

  • I pre-set my realistic profit and potential exit.
  • Most importantly, I want to set a stop-loss at a point where, if it hits the stop, it has clearly broken a technical support area. This is an area where I the stock hits this point, clearly I was wrong.  If I’m wrong, I get out.  I would rather lose my opinion than my money.

Then I take a look at where the potential profit and potential stop-loss are located on the chart.  If the stop-loss is greater than the expected profit, that’s not going to be a good trade.  If the expected profit is at least twice the stop-loss amount, that might be ok.  The higher the expected profit to the potential loss the better!

Let’s take a look at an example.  Look at this chart:

Swing trade with expected profit and stop loss
In this chart, you can see where my entry was in BLUE at $9.70.  I’ve gotten into this trade right at support.  Look at that dogi candlestick.  The stock traded down earlier in the day, but bounced back up, closing at/above the support line, currently priced at $9.77.

I have set my sell stop at $9.10.  That’s below the trading range of my entry day (below the lower shadow of the dogi).  It’s also a decent ways away from the blue support line that I have drawn on the chart.  If this stock trades down to that level, it’s pretty darn clear that the support line is broken and this stock will likely head lower.

Make sure to set your stop loss at a point below a technical support area.  This should be an area where if the stock trades down to this level, you know that things aren’t looking good for your trade.  You don’t want to set it too close to the support area, because support is a general area, not a hard-set line in the sand.  The key is to have it far enough away from the “noise” of the support line, but not too far where you will end up with a larger than needed loss.  Once you set the stop-loss area, stick to it!  Discipline.

Next, I’ve set my expected profit right at $11.20/share.  This is an area where you can see there had been some congestion on the move up and also on the move down.  This is an important point!  Over the next several days, maybe 4-5 days, I’m expecting this to bounce and approach that level.  At that point, the trade might stall out.  To me, that’s a realistic bounce.  I wrote a blog post on how high a potential swing trade might go, so when you get a chance, take a look!

Make sure to set your profit at a realistic point.  Sure, it might go higher than that.  If so great.  Bonus.  If you try to fudge the potential profit point, you are only deceiving yourself.  Put your ego aside, set the likely area that the trade will move and don’t change it.  Discipline.

Once the potential profit and stop-loss points are set, don’t change them…  EVER.  Especially the stop-loss.  So often traders pull their stop-loss orders when the stock is getting close to triggering the stop.  I’ve done it.  Many times.  Maybe you have to?  Sure, it sucks that your trade has moved lower and now you are showing a paper loss.  Triggering the stop means you now actually have that loss.

Here’s the thing…if you decided in advance that if the price got to level, your previous analysis of having the trade move in your favor is clearly wrong.  You were wrong.  it’s ok.  Being wrong is a part of trading.  You can’t be right 100% of the time.  Some traders have successful systems where they are right 40% or 20% of the time.  Some have win rates much lower than that and still make tons of money!  It’s ok to be wrong.

With this particular trade, you can see that I’m expecting to make 2.5 times my risked amount.  I’m risking .60 cents a share and expecting to make $1.50 a share.  For the stop-loss, I might have slippage when my stop is triggered.  My order might get executed at 9.09 or 9.08. That’s just a part of trading.

As the trade hopefully moves up in a positive direction, closer to my expected profit line, I will periodically move up my stop-loss.  Not too close to the current price though.  You want to give the trade some room to breathe.  I might move it up to my actual entry point of $9.70.  At that point, I’m basically going to break even.

If the trade starts to stall out, right around that 11.20 area, I might move my stop up to around $10.80 or $10.90.  Now I’ve locked in a decent profit, and if it keeps moving through that $11.20 congestion area, I’m not going to complain!  I’ll keep moving my stops up along the way.  Who knows, might move up near that $13-$14 range!

I do this for every trade I’m in.  I always calculate my expected profit, the potential loss, and analyze the risk/reward.  Managing my risk in this way has been one of the keys to my success.  Knowing where each trade fits in to your overall portfolio and is one of the keys to developing your trading plan.

How much to risk per trade

So now you’ve calculated your risk/reward potential for a trade, next question, how much to buy?  I have a rule where I never risk more than 2% of my portfolio on any one trade.  Let’s go through some hypothetical examples.

If you had a $10,000 trading account, 2% of that is $200.  If you wanted to buy as much of this stock for a swing trade, how much could you buy, based on where you want to set your stop-loss?  If you entered this trade using your entire account…getting in at $9.70 and immediately set your stop-loss to 9.10, that would be a 6.18% loss!  A heck of a lot more than 2%!  Obviously, in this case, you cannot put 100% of your trading account in on this one trade.

Here is a simple way to calculate the maximum number of shares that you can buy on this trade:

  • If you bought at 9.70 and got stopped out and sold at 9.10, that’s a .60 cents/share loss.
  • Remember, you have a $10,000 trading account, 2% of that is $200.  So $200 divided by .60 = 333.33 shares.  Round it down to let’s say, 333 shares.  That’s how many shares you can buy.
    • This trade will cost you $3,230.10 (333 x $9.70).
    • If it goes down to $9.10, your trade is now worth a total of $3,030.30 (333 x $9.10).  You can see… you have now lost about $200 ($3,230.10 – $3,030.30 = $199.80)

If your stop-loss was tighter, you could buy more shares.  If it was even wider, you would have to buy less.  Don’t try to tweak your stop-loss to make things fit.  You are only cheating yourself.  Set your stop loss based on the chart, the technicals.

Here is the key point to remember about position sizing:

  1. Determine where you need to get out of the trade…the point where your stop loss needs to be.  This should be a point where you technically know that without question, the trade is not working out, it has not behaved as you expected.  Set your stop loss there.
  2. Then go through the calculation above to determine how many shares to purchase.

Putting it all together

I hope this series describing the major framework of how I swing trade has been helpful!  If you stumbled upon this 7th of 7 parts, you can start at the beginning to get a complete picture of my trading system.  Have you developed a trading system? If not, hopefully this series gives you inspiration to document exactly how you will trade going forward, by writing down your plan.  Once you’ve done that, stick to it!  A plan is not set in stone though, so as you notice areas that can be improved, change it!  I do.  But at least follow a basic framework, so you are not blindly chasing trades.

Having a trading plan and actually following it, has been the only reason why I’ve been able to start consistently profit as a trader.

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