Forex swing trading strategies is a simple way to trade currencies which can make great profits and a major advantage of this method is trading is – you don’t need as much discipline as you need to hold long-term trends, as losses and profits come very quickly.
I have always believed, that having the discipline to take losses is relatively easy if you believe in your system but holding longer-term trends is far harder. The reason for this is obvious:
If you are following long-term trends, you will be sitting on a big open equity profit, when the inevitable, short-term pullbacks come against you and eat into the profit, the temptation is always there, to take a profit in rather than let it run..
Trend following means having an open target and in addition, you know that you have to give back a good bit at the end of the trend, as no one knows when a trend in motion is going to end but in swing trading, you will have a set target and when its hit – your out.
Both profits and losses come quickly and this means, you don’t have to have the mental discipline which you need as a long-term trend follower and this, of course, makes swing trading ideal for novice traders.
The Concept of Overbought and Oversold
If you look at any FX chart, you will see trends but these trends, will have reactions to the upside and downside where prices are pushed to far up or down, away from the average price but prices will always return to more realistic levels.
The aim of the swing trader is – to sell into overbought levels and buy into oversold levels and liquidate the trade, when prices have returned to fair value.
Markets will always spike to far up or down in the short term because humans are emotional beings and they make trading decisions based on greed and fear.
This concept is easy enough to understand and will always occur because human nature is constant and greed and fear are reflected in the chart as overbought and oversold levels.
Waves on a Beach
Over the years I have seen some incredibly complex swing trading systems and seen traders who use them, fail with them. When swing trading, you need a simple system because all you are doing is trading the odds and when trading the odds, a simple system will be more robust with fewer parameters to break.
Swing trading is a bit like watching waves on a beach when the tide comes in; You know the tide is going to come in its inevitable but as the waves hit the beach and go backwards and forwards, as the tide comes into the shore, each wave is different in terms of how far it comes in and how far it pulls back.
In Forex market its a similar concept, every scenario is different and while we will lay down some general guidelines, these should still be reviewed by you, in light of the individual trading scenario you are looking at.
I do not think swing trading can be reduced to pure set rules and an outline of rules which you can review on each pair and pull the trigger on is a far better way of trading.
Trading Pairs and Duration
In terms of swing trading there is no best pair to trade, you can trade any of the major currencies or crosses. So long as you have good liquidity, volatility is high and pip spreads are tight, you can swing trade a currency pair – so how long does a typical trade last?
A typical swing trade, will last from between a day and a week and one point we want to make clear – is that each currency may give you 2 – 4 good swing trades a month. You only want to trade when the set ups are right!
I see many traders looking to trade everyday but this just means making effort for efforts sake and you don’t get rewarded for that, just being right. So in conclusion, always be selective in your trading and keep the odds on your side.
Indicators for Swing Trading Strategies
Lets first look do a quick summary of the 3 indicators we normally use and then apply the MACD into the mix. We have repeated some of the information from our previous PDF’S for clarity and ease of reading.
Below we have outlined the various indicators and the logic behind them and then we will give you some tips on combining them into a simple strategy. As per usual, we have given you the mathematical calculations but these are only for those traders who like mathematics!
These are all visual indicators and you don’t need to know how an internal combustion engine works to drive a car and its the same with technical indicators, just look at the visual setups and you will do just fine.
The Relative Strength Index (RSI)
The RSI was introduced to traders by Wells Wilder in 1978 in the legendary book New Concepts in Technical trading and is one of the most widely used momentum indicators in Forex Trading.
General Rules for Using the RSI
Wilder recommended using 70 and 30 and overbought and oversold levels respectively. Generally, if the RSI rises above 30 it is considered bullish and on the other hand, if the RSI falls below 70, it is a bearish signal.
Buy and sell signals can also be generated by looking for positive and negative divergence between the RSI and the currency studied. Because of how the RSI is constructed, the underlying currency will often reverse its direction soon after such a divergence occurs.
Divergences that occur after an overbought or oversold reading will usually provide high odds trading signals. There are other divergences on the chart below but we have illustrated a high and low in price with divergence on the RSI.
Note: The RSI is a tool which is useful but it is not effective on its own in our view and should be used as a backup tool and we like to use it in terms of supporting our favorite timing indicator the stochastic.
This is an indicator which was developed by George C. Lane in the late 1950s and while it’s been around for half a century, we still consider it the ultimate indicator for timing trading signals and its based on a very simple concept:
The indicator shows the location of the current close relative to the high/low range over a set number of periods. Closing levels that are consistently near the top of the range indicate accumulation and buying, while those near the bottom of the range indicate distribution or selling.
There are in fact three different stochastic indicators – the full, the slow and the fast and here, we are going to look at the latter which is a sensitive indicator and ideal for swing trading.
General Rules for Using the Stochastic
Readings below 20 are considered oversold and readings above 80 are considered overbought. However, Lane did not believe that a reading above 80 was necessarily bearish or a reading below 20 bullish, it just shows that the currency studied is either overbought or oversold.
A currency can often continue to rise after the Stochastic Oscillator has reached 80 and continue to fall after the Stochastic Oscillator has reached the 20 level. The best signals occur when the oscillator moved from overbought territory back below 80 and from oversold territory back above 20.
One of the most reliable signals is to wait for bearish divergence to develop from overbought levels or bullish divergence from oversold levels. Once the oscillator reaches overbought levels, wait for a negative divergence to develop and then a cross below 80.
Note: When using the stochastic by its very nature you will get a lot of false signals so you need to trade extremes if using it on its own – you can trade levels which are not extremes and we will look at how to do this in a moment and how to filter signals.
The Bollinger Band
The Bollinger Band is one of the most commonly used Forex technical indicators and is designed to show the volatility of the underlying currency covered. The middle band is a measure of the intermediate-term trend, usually a simple moving average, that serves as the base for the upper and lower bands.
The interval between the upper and lower bands and the middle band is determined by volatility, i.e. the standard deviation of the same data that is used for the average.
The default parameters, are 20day (periods) and two standard deviations:
Middle Bollinger Band = 20-Day simple moving average
Upper Bollinger Band = Middle Bollinger Band + 2 * 20-period standard deviation
Lower Bollinger Band = Middle Bollinger Band – 2 * 20-period standard deviation
So you have a 20-day simple moving average and two bands which expand on high volatility and contract on low volatility and by looking at the price in relation to volatility, you can see how overbought or oversold the market is at the same time.
Remember that buy and sell signals, are not given when prices reach the upper or lower bands! The bands simply indicate that prices are high or low on a relative basis.
A currency can become overbought or oversold for an extended period of time but if you know how high or low prices are on a relative basis, you can spot trading opportunities.
Trading Setups Using The RSI, Stochastic and Bollinger Band
This simple method combines the volatility of the Bollinger Band to isolate overbought and oversold levels to set up possible swing trading scenarios and adding the RSI and Stochastic in as the timing indicators to enter the trades. Let’s take the graph we have just looked at above and add these indicators in:
So general rules of the above method are:
- Look for high volatility and a price spike up or down. Prices need to be at the outer band or even better if they have exceeded it, as per the above example.
- Look for the stochastic to be at overbought or oversold and a turn up to occur
- Look for the RSI to support the move but as its, a supporting indicator prices do not need to be overbought or oversold ( if they are all the better) but they should support the stochastic.
- When the trade is entered, the stop is below the relevant support and resistance level you are trading into.
Target should be a support or resistance level near the Mid Bollinger Band. In many of the above scenarios, prices run on but this is not the object of swing trading; your aim is to set a target just before support is hit, when you are trading short and just before resistance is hit, if you are trading long.
MACD stands for “Moving Average Convergence Divergence” and was created by George Appell. The MA part of the name stands for “moving average.”
Moving averages are trend following tools that have the power to keep the swing trader on the right side of the trade. The CD stands for “convergence” and “divergence,” or the phenomenon of the moving averages coming together and spreading apart.
During a period of a strong trend, the two MACD lines will grow further apart (divergence). During sideways consolidation, they will converge or come closer together, often crisscrossing one another several times.
MACD can be used as a trend following tool but here we are going to use it as momentum tool and the reason it’s so useful for this purpose is that the MACD is an exponentially weighted moving average, the EMA which takes into consideration older price data but weights new data more heavily, meaning it can clearly show overbought and oversold levels and possible entry and exit points for trades.
Construction of the MACD
The MACD line itself is constructed from two moving averages — a 12-period, or faster, moving average and a 26-period, or slower moving average. The computer subtracts the 26-period moving average from the 12-period and creates a single line, the “fast line.”
The next calculation performed is the computing of a nine-period E.M.A. of the main line. This line is called the “trigger line,” The MACD is centred at a value of zero, that is, when both moving averages have exactly the same value.
Its value will oscillate around the center-line over time and how far it is away from the centre indicates whether or not the currency studied is overbought or oversold. The MACD Histogram measures the difference between the MACD fast line (in red) and the MACD signal line (in blue).
If the fast line is above the signal line, the MACD Histogram is positive, and the bars are drawn above the center line. If the fast line is below the signal line, MACD Histogram is negative, and the bars are drawn below the center line.
The MACD is centred at a value of zero, that is, when both moving averages have the same value. Its value will oscillate around the center-line over time, indicating whether or not the underlying stock is overbought or oversold.
General Rules for Using the MACD
Many traders use the MACD divergence to help spot potential trend changes. Divergence is created when price is moving in one direction while the MACD is moving in the opposite direction. This is a bearish sign which indicates a change may be near.
On the other hand, a bullish MACD divergence can form when prices are moving down but MACD is again moving in the opposite direction.
Note: Lots of traders like to use divergence but for us, it is of little use in Forex Trading or for swing trading, the most effective use of the MACD in swing trading is the Crossover which is outlined below:
The most commonly used strategy is the MACD crossover. It is a very simple strategy, the crossover buy signal is created when the MACD crosses above the MACD signal line. On the other hand, a sell signal can be generated when the MACD crosses below the signal line.
The MACD is a lagging indicator, the MACD histogram was developed to help traders identify a possible change in trend BEFORE an actual MACD crossover occurs. The MACD histogram plots the difference between the MACD and the signal line.
The logic is that a trader will be able to see the spread between the two lines increasing or decreasing, as each bar unfolds, therefore, when above the 0 line, a shrinking histogram can indicate a crossover is imminent.
On the other hand, coming from below the 0 line, an increasing histogram can give advance warning of a MACD crossover to the upside may occur. The
histogram warns of a crossover and peak in the MACD line and will confirm it on a good signal by moving from negative to positive or positive to negative to support the move.
Using The MACD with Bollinger Bands, RSI and the Stochastic
Now let’s take the above chart and add in the indicators above and see what the combination looks like and how the indicators come together. We use the stochastic as our main tool to enter trades and the advantage of combining it with the MACD is that it will allow you to filter trades better in terms of entry – this will become clearer if we look at some charts.
When using the above indicators keep the above in mind as general guidelines:
- Always look to trade on high volatility on spikes to or outside of the bands
- Look at the MACD lines in view of – the further away from the center line the better in terms of spotting trading opportunities.
- When looking for trading scenarios – look for the MACD line to lose momentum and check the stochastic and RSI.
- If the stochastic is at an extreme and the MACD line is losing momentum – your signal to sell, can be from the stochastic so long it is overbought or oversold. The MACD line does NOT have to cross ( the stochastic will normally turn first of course) when the MACD does cross though, it will provide additional confirmation for the signal. You should also on all highs and lows, watch the MACD histogram for additional confirmation of falling momentum.
- The RSI does NOT have to be at an extreme when you enter a trading signal – if it is, it adds weight to the move but so long as it supports the direction you wish to trade in that’s fine.
- When setting a target, this will depend on how extreme the move is – but as a general rule, we always look for support or resistance levels, around the mid Bollinger Band in strong trends.
If you use the above general guidelines and trade into price spikes on high volatility, you will have a flexible and powerful set of tools, with which to generate high return, low-risk trading signals.