The full title of this book is The Master Swing Trader Toolkit: The Market Survival Guide by Alan S. Farley (2010). This is sort of like the 2nd edition of his earlier book The Master Swing Trader: Tools and Techniques to Profit from Outstanding Short-Term Trading Opportunities (2004).
I picked up this book after reading a good review of it on Amazon. Frankly speaking, I find this book quite tough going. There’s a ton of information packed into the 300+ pages, but its tough to read because (i) many times I find it hard to figure out what the author exactly means without the help of a chart or diagram showing what he means, (ii) there are lots of little bits of information scattered in large paragraphs which left me thinking “ok good to know… so how can this piece of information be used?”. I think the book can definitely be presented in a more succinct and clearer manner, with a focus on how each piece of information is used in a trading plan.
I have not read Alan Farley’s first book, and this book made mention of the first book a few times, so to be fair, a reader who has read the first book might ‘transition’ smoothly to this second book compared to me starting fresh with this second book.
Regardless, some interesting things from this book are a stock filtering process that supposedly produces a watch list that overlaps with the IBD 100, and a smoothed-RSI indicator for longer-term cycles. Two other things that stand out for me from the book are: (i) entering on retracements after the first wave of action has completed, and (ii) standing on the sidelines and taking opportunities of failed attempts (or rinse jobs).
Program Trading Observations
- The market often prints the highs or lows of the day near the lunch hour. Opening trends tend to fade near the lunch hour and give way to proportional counterswings.
- Directional programs are more numerous in the first hour, near 2.15pm, and in the last 30 minutes of the session.
- Up-down volume higher than 80:20 or lower than 20:80 predicts trend days that show persistent channeling behavior.
- Support and resistance levels are vulnerable to repeated traps, characterized by gaps in the opposite direction of the prior day’s closing momentum.
- Open-to-close daily program strategies are prevalent, with early themes persisting through the entire session but then disappearing overnight.
- As a result of open-to-close strategies, rotation is now a daily event, which is nearly unpredictable through routine technical analysis.
- As a result of open-to-close strategies, intraday trend reversals are less likely than they were 5, 10, or 15 years ago.
Common Cross-Market Relationships
- Inverse relationship between commodities and bonds.
- Inverse relationship between U.S. dollar and commodities, especially gold.
- Positive relationship between stocks and bonds.
- Copper as a proxy for industrial activity.
- Gold as a proxy for inflation-deflation.
- Oil as a proxy for economic growth-contraction.
- A strong dollar favors small cap rallies, while a weak dollar favors commodity rallies.
Options Expiration Opportunities
- Follow-through action in the direction of the underlying trend is far less likely during options expiration period. Don’t expect rallies or selloffs to follow through during expiration week.
- Stocks and indices will move in whatever direction causes the most options to expire worthless on expiration Friday. Stocks and indices will move toward price levels that attract the highest open interest (‘magnetic levels’). These magnets tend to occur with the greatest frequency at round number intervals like 30, 40, or 50 or at half rounds like 25, 35, and 45. Follow open interest in the big ETFs.
- Stocks trading near 52-week highs or lows are especially vulnerable to expiration week shakeout games because these issues attract lopsided call or put buying.
- Buy between Wednesday and Friday afternoon after a strong stock sells off into a strike, or sell short after it rallies into a strike.
- Identify highly liquid stocks under or over magnetic levels early in the week, and then get on board for a trip into the magic number.
- Triple witching takes place during the 3rd month of each quarter with the simultaneous expiration of equities, options, and futures. In uptrending markets, when the index futures roll over into a new forward month on the Thursday prior to expiration week, they will often pull into notable lows on the day before the rollover so that long-term players can buy at more advantageous prices.
- Most shakeouts are over by the start of expiration Friday.
Handling Earnings Releases
- Play the stock into the minutes ahead of an earnings report, but get out before the numbers are actually released. Then examine the crowd’s reaction to the report and trade back into the position when the coast is clear.
- Get out of the way if your stock, or a leader in a related sector, is scheduled to report earnings after the close.
- Directional movement and volatility tend to wash out two to three sessions after an earnings report.
- Run a 52-week high or low scan, creating a list that contains just stocks in the top 25% for a strength list or bottom 25% for a weakness list.
- Strength filter
- Calculate (1 + (Close – 52-week high) / 52-week high) * 100 = % of 52-week high
- Weakness filter
- Calculate (1 + (Close – 52-week low) / 52-week low) * 100 = % of 52-week low
- Strength filter
- Run the above list through the Price vs. 200-day MA scan
- Calculate ((Close – 200-day EMA) / 200-day EMA) * 100 = % above/below 200-day EMA
- This process narrows down to active momentum plays (usually overlaps with IBD 100).
- The best signals unfold when Stochastics (5-3-3 setting) makes a lower high (or higher low) near the 80-20 line and then expands in the opposite direction. This type of pattern will often trigger an entry or exit signal just ahead of price movement and should be acted upon without further confirmation.
- Position traders can use 14-7-7 Stochastics settings to hold through whipsaws and shakeouts.
- Use simple double top or double bottom patterns to pinpoint reversals driven by overbought or oversold conditions.
- Use the 5-3-3 Stochastic to track daily oscillations lasting 4 to 7 days, and 60-minute oscillations (i.e. swings) lasting 5 to 10 hours. The 60-minute version works extremely well in pinpointing the 2- to 3-day buy-sell swings that characterize a typical 5-day trading week.
- On Balance Volume (OBV) is a useful predictive tool when signals are unambiguous and price sits at a key level, testing a swing high/low or a major moving average. Conversely, avoid the indicator entirely when you’re lacking one or both of those environmental conditions.
- The most actionable data come with a strong OBV breakout or breakdown, while price is still stuck at support-resistance. This divergence predicts that price will surge in an attempt to play catch up to the rising or falling OBV. OBV lagging a price breakout or breakdown is a divergence that predicts whipsaws will follow the trend thrust.
- Markets tend to oscillate in 21- or 28-day cycles of strength and weakness (monthly time frame). The best opportunities for position trades tend to appear at the bottom and top of this cycle. A longer-term relative strength indicator exposes these turning points early in a new swing, often before price confirms the reversal through an index breakout or breakdown.
- Use a 14-day Wilder’s RSI smoothed by 7 periods. If unavailable, use a 17-17-1 Stochastics as substitute.
- Avoid long positions when the long-cycle indicator is pressed above the upper line and turning over because the downturn may signal a decline lasting for six to eight weeks at a minimum. Alternatively, you can often time new entry with great precision after stocks have fallen to support, gone limp, and the long-cycle indicator turns higher from the oversold line.
- Look for daily trends to reverse after 3 bars in either direction (Taylor Trading Technique)
- Watch for spikes that pierce the top or bottom bollinger band by more than 75% of the bar’s length. This thrust signals a market that will likely reverse in the next 1 or 2 bars.
- The odds for a reversal increase on Tuesday especially after a trend carries over from the prior week. Reduce risk by dumping positions into that day’s open. Better yet, get out Monday afternoon and save yourself the trouble.
- More reversals take place after an instrument hits a new high or low than at any other time (Vic Sperandeo’s 2B reversals).
- Volatility usually stalls ahead of a reversal. Watch out for markets that stop going up or down and then congest into tight trading ranges.
- Beware of a high volume blowoff. A market will reverse as soon as everyone who wants to buy or sell comes off the sidelines and gets into the action.
- Drop down a time frame and look for reversals in the shorter-term patterns.
- Look for hammers and dojis at key support or resistance levels. Watch for dark cloud cover after a big rally. Stay alert for a harami reversal after a big bar in either direction.
- Rallies and selloffs tend to occur in 3s before yielding to major reversals. Each primary wave should be separated by a pullback or congestion phase. The last wave tends to trigger the most technical divergences.
- A big gap against an active trend, known as a hole-in-the-wall, signals that direction has changed in a single bar. Don’t wait for confirmation [to exit] when the instrument gaps the wrong way and doesn’t fill before the closing bell.
Countertrend Trading Tips
- Going against a high volatility play (vertical rally / falling knife)
- Break up your position into tiered limit orders on both sides of the expected reversal level. Then place a stop loss just below the last order (for longs), and exit the entire position if price drops that far.
- Place a single order just below
- Fading ranges
- Set your stop loss just outside support or resistance.
- Focus your entry near a single price level just behind this intended exit price. Don’t chase positions because they need to execute with minimum slippage in order to keep reward:risk in your favor.
- Once established, the position should be held until price pulls into the other side of the trading range. Then take profits and look for an entry in the opposite direction.
How to Get Off the Yo-Yo Treadmill
- Ration trades – Set a flat figure for the number of trades you’ll execute in a single session, and stick with it.
- Cut size – Smaller trade size helps you to stand your ground in good trades and feel less miserable when stop losses get hit.
- Play a shorter watch list – Prepare a list of 5 or 10 stocks to trade in the next week or month, and don’t take positions in anything else. Don’t trade at all if those stocks don’t set up good opportunities.
- Get it and get out – Set a dollar threshold for daily gains or losses, with the gain size at least twice the loss size. Get out of the market for the rest of the day as soon as either threshold gets hit.
Short Sale Entry Strategies
- Failed breakouts (2B reversals)
- A breakout fails by dropping under the last swing high (usually within 1 to 3 bars after the breakout).
- Sell signal triggers when price trades through the low of the first recovery bounce.
- Occurs either in a well-established downtrend, or in an uptrend where there is a gap down below support.
- Sell signal triggers when price spikes into an obvious resistance level and rolls over, or above an obvious resistance level and then sells off.
- Narrow range
- Look for tight congestion at a key support level after an instrument sells off in a developing downtrend.
- Enter the sell order within the 2- or 3-day range, placing a buy cover stop just above the short-term high in case price turns tail and heads into a larger-scale recovery.
- Momentum entry
- Find an active selloff (e.g. GFC), enter the weakening instrument and ride the downside while protecting your position with a percentage based stop loss.
- Look back at your short candidate’s history over 1 year. Observe what happened whenever support broke. Go for candidates where short selling worked (price didn’t pop above new resistance) or partially worked (price spiked above new resistance followed by another selloff).
- Look at prior periods when the market traded at or near the same price level. Don’t sell short if the instrument printed a series of notable reversals near that price.
- For position short sales lasting at least 1 to 3 weeks, stand aside if the 14-day Wilder’s RSI reaches the bottom 20% of its range and then turns higher. This suggests a buy swing coming.
- Never sell short when a price bar drops 75% to 100% outside the bottom bollinger band (20-period). This suggests a sharp reactionary swing and vertical squeeze.
Short Selling Do’s and Don’ts
- Do short rallies, not selloffs
- Do short the weakest sectors.
- Don’t short the strongest sectors.
- Do watch the calendar (e.g. window dressing, first day of the month, options expiration). Short sales taken during the choppy midday hours are less like to profit than first or last hour positions.
- Don’t short a dull market.
- Don’t avoid big story short sales (e.g. housing and financials in 2008). Avoid shakeouts by using weekly charts.
- Do watch closely for false breakouts, especially when there is bearish price action in longer time frames.
- Don’t second-guess. Put a well-placed stop loss, and be patient while the market is shaking around and probing higher levels.
50-day EMA Strategies
- Retracement to 50-day EMA
- After a new breakout, place an alert a point or two above the 50-day EMA, and wait. Once price returns, look to buy when the selloff gathers steam into the MA, or wait until the pattern in the next lower time frame (e.g. 60-minute chart for a daily setup) carves out an upside reversal pattern.
- Narrow range at 50-day EMA
- Price breaks down on strong volume, eventually finds support, and recovers back to 50-day EMA. Bounce stalls, and price bars contract right across the MA. Stock then drops like a rock.
- Sell short within the narrow range bars at MA resistance. Don’t wait for the selloff to begin and then chase the market lower.
- Combine with other time frames
- Locate a pullback where the chart shows different types of support or resistance at the same level as the 50-day EMA. This also works well in combination with overbought/oversold levels on Stochastics / Wilder’s RSI.
- Zoom in to a 60-minute chart, use the reversal pattern there to take an entry when the 60-minute pattern breaks out or breaks down.
First Hour Range Breaks
- Stick with highly liquid stocks that trade over 5M shares per day on average.
- Stocks that are already trending at the end of the first hour (and not swing back and forth) should not be traded using this strategy.
- Only enter when risk:reward is at least 1:3.
- Buy / sell a few cents above / below the upper / lower end of the range with a full position (don’t scale in). Use 5-minute bars.
- Stop loss for a long = Range high – 15% to 20% * Range height
- Stop loss for a short = Range low + 15% to 20% * Range height
- Profit target = The last major swing over the last 2 days using 15-minute bars. If there’s no swing, use a tight trailing stop and get out at the close if the stop doesn’t get hit first.
- This same technique can be used to trade breakouts / breakdowns from consolidation patterns.
- Match stop with trade type
- Stop placement should match your intended strategy. If you are looking for a multiday move, pull the stop back and risk more capital in the initial stages of the new trade. If you’re planning a quick scalp, press the stop against the advancing instrument.
- When to protect profits
- Don’t shift into profit protection mode until the trend ejects in your favor through wide range bars.
- How to trail stops
- Pull up a lower time frame chart (60-min if you are trading off the daily chart, or 15-min if you are trading off a 60-min chart). Look at recent action for congestion zones between your entry price and the current price, place the stop just behind a congestion zone.
- Move the trailing stop each time price ramps to a new level and deposits a sideways pattern on the intraday chart.
- Continue this process until the position reaches about 75% of the distance to the profit target, then pull your trailing stop aggressively behind the advancing price + place a limit order to close the position right at the profit target (sandwiching the market price).
- Placing the best stops
- Wait until the commonly placed stops are run, then jump in as soon as momentum fades. After a long entry, place the stop loss one tick below the rinse job extreme.
Indications of a Trend Day
- NYSE TICK probing greater than 1,000 or less than -1,000 repeatedly.
- Advance/decline greater than 1,500 or less than -1,500 on both exchanges.
- Advance/decline greater than 2,000 or less than -2,000 on one exchange.
- Up/down volume in both exchanges greater than 4:1 or less than 1:4.
- S&P 500 and Nasdaq-100 index futures up or down more than 2%.
Strategies for Trading Gaps
- Wait for a postgap range to develop, and trade the breakout in the direction of the new trend.
- After a breakway gap, wait for a low volume retracement, then enter in the direction of the gap, right at the gap fill (i.e. the place where price enters the gap) or when it breaks the trendline of the retracement swing.
- After an extended rally or selloff, and an exhaustion gap appears, enter a trade in the opposite direction of the trend prior to the gap.
Traps and Rinse Jobs
- Trapping behavior is most common in the latter phases of established trends, in which one side is controlling the tape.
- Rinse jobs mark a great opportunity if you’re coming off the sidelines. Realistically, the buy-sell imbalance will persist for just 3 to 5 sessions before new money comes in and equalizes the equation.