Swing Highs and Swing Lows: Are We There Yet?


Many traders count themselves amongst the legions of “swing traders,” entering long or short positions as price approaches potential swing highs or swing lows. Other traders are intraday scalpers and use swing highs or swing lows as formations to hide stop loss orders above or below, taking advantage of the build up of entry orders from swing traders at these regional extremes. But the question to both groups of traders is always the same: Are we there yet? Have we reached the buying zone or selling zone?



By definition, swing traders are always trying to sell rallies in a down trend and buy dips in an up trend. Then they can try to ride the “swing” or swings higher, running trailing stops that “box” in their profits as price moves in their favor.

But the peril is always the same: Has a recent rally within an established down trend finally reached an area where a top will form and price will then return to the major down trend—OR—Has price violated the down trend and a new up trend had begun? As a swing trader, you always run the risk of being “hit by the train” of a change in trend. Is there a way to better gauge whether price is running out of energy and is about to turn OR is likely to continue, running right through its likely stopping area?

I’ve done a tremendous amount of charting and statistical analysis over the past five years developing tools to keep me from “stepping in front of the train” of newly emerging trends. And one of the most useful ways I have found is to analyze the qualities of the price bars as they approach these likely turning points. The quality I am looking for I have named “Separation” and hopefully these charts and this description will help you successfully identify turning points and keep you from stepping in front of the trains! Let’s look at a chart:



In this example, price has climbed higher and I added in a down sloping pitchfork, or Median Line, to show me the potential path of price IF I have identified a swing high. But note that this upper red line has not been “tested” by price. To relate this term “tested” to trend lines, trend lines are generally drawn by connecting two prior highs or two prior lows. If you choose a prior high and then randomly pick a point in space, rather than draw the trend line by connecting it to another prior high, you get a line in space that has a slope that may or may not have meaning—you won’t know until it is tested. An untested Median Line has a bit more validity because of the mathematical relationship of the three alternating pivots used to draw it, but it becomes much more valid once it has been tested.



To make the analogy easier to understand, let’s turn the down sloping line into a simple trend line. And we’ll state up front that this trend line is drawn from two prior high pivots. Now we have an area where we think price MAY stop at, but WILL IT stop at this trend line?

Let’s think about what would make it stop at the trend line: Price has topped out twice at this area. This leads traders to feel it’s likely to follow the same pattern. So there may indeed be good orders to sell at or above this trend line, because price has stopped here before. One famous trading motto is: “Beat on a line that is working until it beats you”. If there are a good deal of traders waiting to sell at or above this trend line, price will test it and price will fail to go higher—and probably run a good bit lower in a short period of time as traders try to get short as it becomes obvious that a top is forming.


Now what would make price run higher through this line? If most traders are already short this market, either from the prior test of this trend line or from other areas, they may have a great deal of stops being worked in the market just above this trend line. If this is the case, once price tests and begins to violate this trend line, price will accelerate through this trend line very quickly and move higher.



If price approaches the trend line but does not test or violate it at all, I still won’t know if a top is in, because I won’t know if there are sell orders or stop buy orders above the trend line. Because price hasn’t yet “peeked” beyond the doorway, I don’t what is beyond it.



Here you can see that once price ran up above the trend line formed by prior highs, there were lots of stop loss buyers and these orders pushed prices much higher—and price closed well above the trend line that I originally wanted to get short against. The distance above the trend line that price moved is our first look at “Separation”. In this case, price closed with good separation above the trend line, which shows good buying interest. There is NO sign of weakness on this chart and no reason to attempt to pick a swing top.



In this example, price tested the trend line, ran a bit higher when some buy stops were hit and then suddenly found nothing but eager sellers waiting to get short as the buy stop orders disappeared. Note that price went well above the trend line but closed well below the trend line, which is also great “Separation,” but in this case it is down side separation and is a major sign of weakness.



Having the upper separation, even though the lower separation gives me the sign of weakness I wanted to see before trying to enter a short position, is important because it tells me price gave the buyers all the chance in the world to take control of this market and they failed to take control. And once the sellers took control, they ran price back down through the trend line and quite a bit more—Again, a sign a major weakness.



In this case, price barely peeked above the trend line, giving me no up side separation. Although price then traded quite a bit lower, I am not as confident about the test of the trend line, because there may still be nothing but buy stops waiting above the trend line. And as price turned lower, new short positions were probably added. But these new short positions do not have much profit in them and any turn back up to re-test the trend line may run into not only the original stop loss buy orders that have accumulated there, but may also run into additional stop loss orders because of the fresh new short positions from this recent move down.



Here you can see price climbed well above the trend line and did find enough sellers to push price back down to just below the trend line. So there is good up side separation but poor down side separation. This means that even though we found solid sellers once all the buy stops were run above the trend line, we did not find enough aggressive sellers to push price a good amount below the trend line—which would have been a sign of weakness. In this case, I am afraid of the old saying: “What was resistance is now support.” The new short positions established at or above the trend line do not have much profit in them and any move back above the trend line is likely to again provoke a fresh round of stop loss buying, pushing prices to new highs.



Let’s look again at an example with good upper separation and good lower separation. When both are present, we know price gave the buyers every chance to take control of the situation. But once the market ran out of buyers, fresh sellers came into the market and took control, pushing price back down through trend line and forcing it much lower, leaving good down side separation. Having separation above and below the market tells me that the area has been “well scouted” and the close of the bar tells me whether buyers or sellers were in control. In this case, the area was “well scouted” and the sellers were clearly in control when the bar closed. This is a sign of major weakness.



Once we have good upper and lower separation and price closes on an extreme, how can we enter the market? In this case, price closed near its lows and gave me a major sign of weakness after leaving good upper and lower separation. IF price re-approaches the trend line, I will get short as it approaches that area and my stop loss orders will go above the high that marks the upper separation. I expect to find sellers above the trend line because they so convincingly took control the last time price was above the trend line. So I expect the sell orders will act as a buffer, or protection, and I purposely hide my stop loss order above this recently made price formation. These orders should effectively keep me from being run over “by the train”.



Now let me simply put the slope back into the trend line. Again, we see great up side separation and great down side separation. And price closed near its lows. The sign of weakness is obvious and if price comes back up to the down sloping line, I would initiate a short position and my stop loss order would go above the top of the recently made high—just above the upper separation. I expect fresh sellers will emerge to help buffer any rise above this trend line, which will help protect my short position.




Other traders often ask me how to identify swing highs or lows “as they occur” and if my analysis is correct, at the end of the day, I’ll be able to look back at this peek above the trend line as swing high. And so as it unfolds, I refer to these potential extreme bars as “Pseudo” swing highs or lows. As you get more practice watching price action unfold in “real time” and learn to think several steps ahead as price tests these areas, you’ll begin to see more “Pseudo Swings” in real-time and that’s when you’ll begin to catch swing highs and swing lows and still do a good job missing being hit by the run away trains!

Good trading to you all!
Thursday, June 28, 2007
Tim Morge

Trading And Teaching: Parallel Lives

Traders on the internet, on my forums and at the various Traders Expos I speak at often ask why I teach seminars, write books and write articles and mentor traders. ‘Why would a professional trader with 36 years experience waste your time teaching—it just takes away from trading!’ is what I hear over and over.



The simple answer is that I find teaching is fulfilling. I find meeting other traders at the Traders Expos, whether they are just starting out or have been trading 40 years, is something that just makes me feel good. And I write because I like to write. I don’t do any of these activities to make money—I trade my own money and manage money for three large offshore funds and that’s my ‘profession’, but teaching and writing fills a need that trading doesn’t fill. Sometimes, when I least expect it, I learn something from those I am teaching to trade; and that’s a wonderful bonus. But teaching and writing is food for the soul to me.



And when I take a winning trade and then do a mentoring session a day or two later and watch a student going through their own trades with me one on one and they start diagramming out the same winning trade, it really makes me smile. I not only managed to make money on the trade, but I managed to teach someone else how to successfully read the market and use my techniques—and we BOTH made money on the same trade set up. That really is the ‘icing on the cake’.



Let me show you a recent example from the 30 Year U.S. Bond Futures:


Bond futures prices consolidate and then breaks higher, above the Swing High.


Bond futures were in a gentle up trend, making higher highs and high lows. Then they had a nice sell off before entering a trading range. Once price restored its energy by trading in the Energy Coil or congestion area, it broke to the up side and took out a Swing High. This was the first sign of strength since the sell off, so once price broke above the Swing High, I added in a blue up sloping Median Line and its Parallel Lines.




Bond prices climb steadily higher, easily breaking above the Median Line before pulling back.

Once price broke out of the Energy Coil or trading range, it traded straight up in an orderly fashion, easily breaking above the up sloping blue Median Line. But price had climbed about a full point without resting to restore its energy, so it was unable to hold above the up sloping Median Line. You can see that the last bar on the chart above zooms lower, through the up sloping Median Line, and closes on its lows with great down side separation—which is a sign of weakness.



When price breaks and closes below the up sloping Median Line, I added a red down sloping Median Line set.

When price zooms through the up sloping blue Median Line and closes on its low, I add a red down sloping Median Line and its Parallel Lines. You can see that price has already tested this new down sloping Upper Median Line Parallel, so I now have two sets of Median Lines on my chart—one up sloping and one down sloping—that have been tested. Though it sounds like it will only confuse the issue, instead it spawns areas where Lines of Opposing Force meet—and I call these areas Energy Points. My research has shown that these Energy Points can act as price attractors, giving me both a price target and in some sense, a good feel for the time it will take price to make it to any specific Energy Point; in other words, you know where price SHOULD go and how fast it SHOULD get there. Of course, price doesn’t always cooperate, but the probabilities once price starts heading for these areas is quite high, so they are quite useful.


Price leaves double bottoms but note that there is no price structure that will draw in natural buy orders where I can hide my stop orders.

You can see on the chart above that price did head down toward the area where the up sloping and down sloping Lines of Opposing Force met, but price drifted too far to the right [in time or space] to touch or interact with that Energy Point.



Instead, price tested the up sloping Lower Median Line Parallel and it closed nicely above it with great separation. This close is the first sign of strength since price broke back below the up sloping Median Line. But I could not consider simply buying Bond futures at this line, because there are no natural price structures [swing lows where other traders will have resting limit buy orders, for example] to hide my initial stop loss order below.



At the moment, I am left with a gorgeous chart. Price stopped where it was supposed to, leaving double bottoms, but there is no good trade entry set up.




Price tests the up sloping Median Line again and closes with good up side separation.

Four bars later, price tests the up sloping blue Lower Median Line again and it closes with good up side separation—which is again a sign of strength. Price is now making higher lows, so I can now use the prior test of the Lower Median Line Parallel as a Swing Low—because there should now be traders placing limit buy orders at that prior low—and I can hide my initial stop loss sell order below this Swing Low. Let me show you what I mean:


I want to buy a re-test of the up sloping Median Line. You can see my initial stop loss and profit targets diagrammed as well.


Now that I have a Swing Low to hide my initial stop loss below, I can use one of my favorite entry techniques: the ‘Test and Re-test’ entry. Price has just tested the up sloping Lower Median Line Parallel and if it comes back down to re-test it, I will be a limit buyer there, at 113 20/32. My initial stop loss will be three full ticks below the low of the first test of this up sloping Parallel Line, at 113 16/32. I’m risking four full ticks in the bonds, but what is a reasonable profit target?



I have two Median Line sets on this chart and at least for the moment, it’s not clear to me which one will act as resistance to price. Do I place my initial profit target at the down sloping red Upper Median Line Parallel or do I place it at the up sloping blue Median Line? Both targets offer me better than 2:1 risk reward ratios, so either would be acceptable. There isn’t a huge difference in price while I am diagramming out this trade, but remember that as price moves to the right, the difference between the two potential profit targets will get larger and larger. Is there a way for me to get a better feel for which line is more likely to work?




Note that I measure the undershoot from the down sloping Median Line and then transfer that same measurement above the down sloping Upper Median Line Parallel.

Note that I measured just how far price stopped above the down sloping red Median Line on its second test of the up sloping blue Lower Median Line Parallel—the area where I want to get long. Then I transferred that same distance above the red down sloping Upper Median Line Parallel. I added in red Sliding Parallels at both areas to make the measurement easy for you to see.



And now, right in front of me, is a new Energy Point that SHOULD act as a price attractor. It’s the area where two Lines of Opposing Force meet: The red down sloping Upper Sliding Parallel I just added in and the blue up sloping Median Line.



Are there any other clues?




Here are my limit buy orders, initial stop loss orders and profit orders mapped out for you.

Looking to the left, I notice that there is already a significant Swing High at the same area—and so I simply add in a horizontal blue line to mark the potential ‘Double Tops’ that might form IF price gets attracted to this area and runs out of energy.



You can see I have diagrammed my limit buy order, my initial stop loss order and now I have added my profit order at 114 06/32, at the Energy Point.



Now that I have settled on a profit target, I enter my limit buy order and my initial stop loss order. I can’t place a profit order until I have a position! Let’s see if the markets let me in:




Once price climbs higher with a large range bar, I move my initial stop to break even.

Price did come back to re-test the up sloping blue Lower Median Line Parallel, getting me long in the process. Once I check that my limit buy order has been filled at 113 20/32, I enter my limit sell order at the Energy Point at 114 06/32.



You can see that price spiked higher and at the close of the bar that got me long, I had a potential eight full ticks of profit in the bonds—and that’s too much money to let turn into a loser [$250 a contract]. I cancel my initial stop loss order at 113 16/32 and move it up to break even, at 113 20/32. I would move it higher, but there is no natural market structure to hide my stop below.



Price is dragged higher, right to the Energy Point at the Median Line and the prior Swing High. I exit my position at my limit sell profit order, taking a nice profit out of this Bond futures move.

You can see that price traded right to the Energy Point at 114 06/32, filling my profit order. Even though I use the areas where these Lines of Opposing Force meet in my trading day after day, I am still amazed when they act almost like an elevator, pulling price nearly vertical to an Energy Point. But I see Energy Points attract price in this fashion over and over again. Once you learn to identify them, they are wonderful sign posts in the markets to use when you trade, giving quality price and time projections.



I mentioned at the beginning of this article that ‘when I take a winning trade and then do a mentoring session a day or two later and watch a student going through their own trades with me one on one and they start diagramming out the same winning trade, it really makes me smile’. In this case, I had a mentoring session the very next day with a beginning trader that had had three prior one on one mentoring sessions with me and halfway through the session, he began to show me this same bond trade and my face broke into a broad grin. I didn’t interrupt him as he told me in great detail how he stalked the entry, how he carefully chose his initial stop loss area because there should be limit buy orders there that would act as protection for his stop loss order. To be honest, we chose different profit targets: he chose to put his profit order at the red down sloping Upper Median Line Parallel, partly because it was the more conservative of the two targets. And he did not ‘see’ the undershoot/overshoot that I used to draw in Sliding Parallels, so he didn’t have an Energy Coil on his charts where the two Lines of Opposing Force met.



But his entry was identical and his stop was picture perfect, hidden below the prior Swing Low to take advantage of the likely limit buy orders resting in that area. And although I squeezed a few more ticks out of the trade, I’ll bet he was more excited about his winning trade!



But I got the satisfaction of knowing that someone was now making money using the methods I taught him. And odd as it sounds, I probably got more satisfaction from him seeing and executing that winning trade than I got when I made the same winning trade the day before.





"Master your tools, Master Your Self." ®

I wish you all good trading.

Timothy Morge

Currency Traders: The Fed Has No Clothes! Part 5

(Or, in other words: What’s Going To Happen With the US Dollar?)

Let me explain the state of the currency markets in the 1980’s: More than ninety-five percent of all cash currency transactions were made through banks. Brokerage firms did not offer cash FX prices, companies had to deal through banks and cash brokers only dealt with banks and a select few Investment Firms. The banks controlled the flow of all the cash currency transactions and other than outright position limits and cash FX trading was basically unregulated in the bank arena.

Today, only roughly fifty-five percent of the transactions in the cash FX market go through banks. The rest go through exchanges, FCMs that make markets in cash currencies to retail and institutional customers and through the electronic brokerage service, a brokerage clearinghouse that allows very large net-worth individuals, corporations, banks and investment firms to deal direct. These days, General Motors can sell dollars directly to a large private speculator through EBS. The days when the handful of large banks in the world controlled the cash FX markets and could really influence flows are gone. Banks no longer have the risk tolerance to carry the huge speculative positions we routinely carried in the 1980’s—they have credit risk and mortgage portfolio problems to worry about. Risk has shifted largely to the speculating crowd and the central banks don’t have control of that crowd. For better or worse, control of the cash FX market has shifted from the few to the masses and that has greatly diminished whatever power the central banks had, IF they ever had the power over the cash FX markets traders attribute to them in ‘the good old days’ of cash FX.

The dollar is currently in a very strong down trend. Until that long-term trend changes, the central banks know that buying US dollars against the major currencies is throwing money away. They do not have the reserves or the sheer power to turn these long-term trends in the cash FX market. And in the case of the United States, the Federal Reserve has so many other urgent matters it needs to address, the dollar’s level is not even on the list of policy items worth pondering.

Currency traders shouldn’t spend any time or emotion worrying about whether the central banks are going to stop the dollar’s slide. The truth is quite simple: when the flow of capital out of the United States ends, the slide of the dollar will stop. It’s well known amongst the larger market participants that the countries that had traditionally held the majority of their reserves in US dollars have been diversifying their reserves out of US dollars and into other currencies. China and Japan have sold a huge amount of US Treasury Instruments and then sold the US dollars they received from these sales—many insiders estimate that China now holds less than 1/3 the US assets it held three or four years ago.

With the emergence of several new large economies [Europe, China and India] that are beginning to rival the US in buying power, investors around the world realize that ‘flight to quality’ may not necessarily mean a move into US denominated assets. As little as six months ago, when I mentioned it might soon take three US dollars to buy one euro, people generally felt I was overreacting to a short-term down trend in the dollar. But these days, it’s become clear that the United States is not in the driver’s seat when it comes to determining the level of the dollar, the level of their own interest rates and the capital flows in and out of their own country. The markets will take the currencies where they take them and the central banks, like all other traders, can go with the flow or stand aside—anything else will result in losing positions that eventually will be liquidated.

I wish you all good trading!

By Timothy Morge

Currency Traders: The Fed Has No Clothes! Part 4

(Or, in other words: What’s Going To Happen With the US Dollar?)

For the next three years, the central banks intervened aggressively in the currency markets, and they made it a habit to try to get the most ‘bang for their buck’ by confirming their intervention and usually leaking their intent to intervene before the markets even opened to a select few traders. And so it seemed to many traders that the central banks ‘called the shots’ and had complete control over this market. And when traders today talk about those three years and talk about the Fed and the other major central banks in general, they seem to feel they are fairly invincible when they want to take action. But nothing could be further from the truth.

Like all things in life, if you use a trick too often for too long a period of time, people get used to it and it begins to lose its effectiveness. The dollar had fallen so far, traders that tried to sell as soon as they heard the central banks were intervening usually found themselves short US dollars at poor levels, because they had jumped in and sold the break out to new lows. After several years of seeing the same announcements and watching the central banks pummel the markets, traders simply got smart: when the central banks intervened, they simply stepped out of the way.

Once the general market stopped jumping on the bandwagon when the central banks announced they were intervening, the traders the central bankers were using also quit initiating their own new short positions—instead, when the phone rang and they got the order to sell dollars, they’d simply execute the order and then go back to what they were doing. This indifference to the central bank sell orders quickly highlighted the truth: without a trend, the central banks were just market participants. The size of the cash FX market is so large, no one player or even five or six players—even five or six or seven central banks—can turn a major trend around in the cash FX market. The trends in the cash FX markets come from huge capital flows and only long-term changes in the policies that cause these flows eventually stop and turn the trend.

When traders these days think about that three year period, they believe the Fed and the other central banks changed the trend in the dollar and sent it reeling lower; time gave the central banks ‘super hero powers’ they never had in real life. The dollar had been falling for more than six months and had declined more than twenty-five percent from its highs before the central banks even started to plot the Plaza Accord in 1985.

When they finally acted, they jumped on a fast moving train: The dollar was already in a very strong down trend and they simply advertised their blessing of the existing trend. Here’s a chart that shows where the US dollar peaked and just how far it had fallen before they began to blatantly sell dollars:



More in part 5…

By Timothy Morge