Swing trading is a way of taking advantage of market retracements to get better entries and more profitable trades.
In this article I show a simple method to trade the S&P 500 using a swing trading system. I look at the historic profitability of the strategy and I also use a random entry test to see how robust the entry system is.
What is Swing Trading?
Swing trading is pretty straight forward. It is a way to using the normal market retracements to get enter trades.
The way I particularly like to use swing trading is to combine it with the overall market trend The image to the left is a good example of how I want to use swing trading. I have highlighted the potential entry points using green arrows. In this example the long-term direction of the market is upwards. Therefore I am only going to trade in this direction.
Done well, swing trading enables us to maximize our potential gain while minimizing our potential risk. We can enter trades that have favorable reward/risk ratios and increase our chances of remaining profitable over the long-term.
Like all trading approaches swing trading has downsides. During strongly trending markets, swing traders can miss good trading opportunities if the price does not retrace.
The Simple Swing Trading Strategy
This strategy has three main parts:
- A direction filter
- An exit system
- An entry trigger
For this strategy I use Standard Deviation Channels to identify the dominant trend. I think these channels are an excellent way to identify the market direction. The strategy is long only and if the channels are pointing upwards I will enter a trade.
The exit strategy that I am using is Bollinger Bands. Bollinger Bands expand during market volatility and contract during quiet times.
The entry trigger is a Japanese Candlestick pattern. In fact I use a very simple pattern. I wait for the price to close below the lower standard deviation channel and then look for a bearish candle. The bearish candle must have a body a minimum percentage of the height of the candle.
Trading Backtest Results
This trading backtest was carried out using a Tradinformed Backtest Model. They are a great way to test your own strategies and really improve your trading skills.
I tested this strategy on the S&P 500 index on the daily timeframe. I used data from 1990 to 2016.
For the results below I had a stop-loss calculated at 3 times the ATR. I set the Bollinger Band multiplier to 1.5 standard deviations. The standard deviation channels were calculated based on 200 days and were offset by 0.5 standard deviations. The body of the candlestick entry trigger must be at least 65% of the total height of the candle (between the high and the low).
|Gross Winning Trades||$294,889|
|Gross Losing Trades||$-118,945|
|Net % Gain||130.2%|
|Average Winning Trade||5,362|
|Average Losing Trade||-5,664|
|Largest Winning Trade||$19,261|
|Largest Losing Trade||$-8,142|
Random Entry – How Robust is the Entry System
As good backtesters and traders we must always be suspicious of our results. It is so easy to allow bias and over-optimism to affect our results. In this case I have decided to test how effective the candlestick entry trigger is. So I am going to compare the candlestick entry to a random entry. I will leave everything else the same. I have carried out 5 random entry tests and taken the average values.
|Gross Winning Trades||$201,475|
|Gross Losing Trades||$-98,624|
|Net % Gain||93.0%|
|Average Winning Trade||3,625|
|Average Losing Trade||-4,637|
|Largest Winning Trade||$10,581|
|Largest Losing Trade||$-6,378|
The original results showed that this swing trading strategy has been profitable over a long period of time on the S&P 500 index. It has a relatively high percentage of winners and has relatively low drawdown. Comparing the original results to the random entry test demonstrated that the entry trigger performs better than random entry in this test. It also shows that the filter and exit system can be profitable over the long-term without completely relying on the entry trigger.
If you are interested in exploring more about swing trading I really enjoyed reading Swing Trading For Dummies by Omar Bassal. It is a good introduction to the subject. I am a fan of the For Dummies series, in this case there is a good use of humor and the material is clearly presented. The author includes a lot of information and trading ideas.
Another good way to improve your swing trading is to use Fibonacci Retracements. In my article on Calculating Fibonacci Retracements Automatically I show my method for putting Fibonacci Retracements levels into an Excel spreadsheet.
It can be easier to understand a strategy by watching. Check out the video of me demonstrating the strategy and backtest spreadsheet.