Identifying Swing Highs and Swing Lows

I always pay strict attention to price formations when evaluating any market. Swing highs and lows are two of the most important formations to learn to identify. Many traders use these areas as entry areas on pullbacks when trading with the trend. Because their orders will be there as a ‘buffer’ to slow the counter-trend rise or fall of price, I often hide my orders above swing highs and below swing lows. But many traders, especially those just learning to read charts, have trouble understanding just what it takes to make a particular high a ‘swing high’ or a particular low a ‘swing low’.

Let’s start out by looking at two types of line charts that show swing highs and lows. By line charts, I mean the actual bars of data are not shown; instead only the extremes of price swings are connected, to give a chartist a clearer picture of the past and current price swings.





The first chart shows a specific method of charting swing highs and lows that was developed by W. D. Gann in the first half of the 1900’s. The second chart shows a more common method of charting swing highs and lows and it is this second method that I’ll be describing in this article. Note that in general, when marking swing highs and lows, I do not specify that X bars have to pass before a new swing high or low can occur. Instead, I let price formations confirm each new price extreme—and that’s the key to understanding what makes the top of a particular bar a ‘swing high’.



Looking at this chart, I have already marked in a Swing High “A” and a Swing Low “B”. And note that price has now climbed above the price extreme I labeled Swing High “A”. Does that make this new high in price a swing high? No, because I don’t yet know whether the new high is in place or if price will continue to work its way higher. In the back of my mind, I should be thinking that price is ‘working’ on a new swing high. But it is not a swing high until a price formation confirms it as an extreme high. It’s not as confusing as it sounds. Let me try to show a better example of extremes that are not yet confirmed by price formation extremes:



Looking at this chart, I see a series of lower lows and lower highs that came after price made an extreme high. But note that price has not yet traded below the prior low [at the far left of this chart]. Nothing yet says to me: “The extreme low is in for this swing!” That means a true swing low has not been put in yet. Let’s look at another example:



At first glance, it looks as if price left an extreme high and then traded lower and most traders would be tempted to say a swing high had just occurred. But is it a swing high? In this case, price made a new high and then came down and is now re-testing the prior low—In fact, at the moment the last bar is part of “double bottoms”, which is an important price formation but cannot be used to confirm a swing high or low. Only a low lower than Swing Low ‘A’ can ‘confirm’ the high that price made two bars earlier as a true swing high.



Price breaks below the double bottoms and the low of Swing Low ‘A’ and that confirms the high three bars earlier as Swing High ‘B’.



It takes new lows to confirm Swing Highs and new highs to confirm Swing Lows. Trading these back and forth motions in the market is swing trading.

Once you learn to identify swing highs and swing lows, you can begin to anticipate what it will take to make the next price extreme a swing high or low and how to use that in your trading.



Swing High ‘B’ is confirmed when price breaks below the prior low that formed Swing Low ‘A’ and note that price is now making a series of lower lows and lower highs. Has price made a swing low yet? Remember, only a new swing high above a price extreme can confirm a swing low. There is nothing yet to even hint that price has made an extreme low.



After the sharp fall, price consolidates, forming an Energy Coil [an area of tight congestion]. Energy Coils is generally a sign that price is re-storing energy, taking a break after an extreme move. Note that they are often followed by a series of false break outs, so it can be dangerous to blindly buy or sell break outs from these areas. Did price just make a new swing low? Let’s take a closer look:



I view the Energy Coil and the engulfing bar before it as a price formation. Now that price has climbed back above both the Energy Coil and the engulfing bar before it, the double bottoms below the Energy Coil are confirmed as Swing Low ‘B’. This is a classic bottoming formation, by the way, and unless price quickly ‘zooms’ through this area to the down side, this area should provide very good support. Note that we cannot identify a new swing high yet.



Once price breaks below the double bottoms that formed Swing Low ‘B’, Swing High ‘C’ is confirmed. It is this back and forth actions that swing traders learn to anticipate and trade. The better you are able to anticipate the formation and confirmation of these swings, the better your swing trading will be.



Even though price briefly penetrated the bottoming formation of the Energy Coil, this area holds a great deal of support and price soon trades higher, above Swing High ‘C’ and that confirms Swing Low ‘C’.

Understanding the nature of swing highs and swing lows is not difficult once you take a few apart and see just how they are built and what it takes to confirm each new swing.

I wish you all good trading!

Tim Morge

Swing Trading: Waiting for the Sweet Spot!

Waiting is one of the most difficult things for traders to do. Traders are generally high-energy individuals and the time spent between trades can often seem like unbearable agony. But it is important to remember that the market is always trending and when it is in a resting phase [congestion], waiting is usually the prudent thing to do. Positions initiated while the market is resting are generally "guesses" about the eventual breakout of a congestion area by a trader-and guesses are generally not very reliable. Rather than guess, I would rather wait for the market to show me which way it has decided to go before jumping in.

The chart below shows a typical congestion phase in the market. Price swings are showing both higher lows and lower highs-which means the range is narrowing as price restores its energy. Price will break out of this congestion area but at the moment, we can only guess whether price will break out to the up side or the down side.



If you look at the last bar on the chart, you can see that it is a wide range bar that breaks below the red down sloping Upper Median Line Parallel and closes well below it-with great separation! Does this bar give me the clue I need to choose a side?

It's an impressive looking bar at first glance but if you examine the chart carefully, you'll immediately see that although the bar has a wide range, it doesn't break below any of the prior swing lows. So it's simply a wide range bar still within the existing congestion. I need a clearer sign from price before I put my money on a trade.



Now price comes down and tests the blue up sloping Lower Median Line Parallel. Once price touches this lower line, it moves back higher and closes well off its lows with good separation. This last bar 'tested' the blue Lower Median Line Parallel but it didn't break below any swing lows.

Can I go long here, since price stopped at the blue up sloping line and closed well above it? Where would I put my stop loss order? I like to place my stop loss orders above or below price formations and there are no price formations to hide under. I still don't have enough information to place any money on a trade.



Now price trades a little higher, testing the red down sloping Upper Median Line Parallel it broke below several bars back. But there's nothing new about this area and price didn't' close above this line with any separation-and even if I wanted to go short there is no formation to hide my stop above. I'm still waiting.



Here's an interesting bar! Price breaks well above the red down sloping Upper Median Line Parallel but the rally fails miserably and price closes in the lower third of this wide range bar-which is a sign of weakness. But I'm not ready to take a position yet because price is still stuck right in the middle of the current congestion and it hasn't given me a single clear clue where its going when it breaks out.



This narrow range bar does nothing to shake my conviction that price is still congesting. Price has been above the red down sloping and below it, but price is really marking time. I'm waiting for a clear sign.



Price trades a little lower, testing the blue up sloping Lower Median Line again-so technically this is the 're-test' in a set up I trade consistently called a 'test and re-test'. But the re-test comes four bars after the original test and I prefer to trade on re-tests within three bars. I have found that the longer the re-test bar takes to occur, the less reliable the set up is. And just looking at the chart, price is still doing nothing more than working back and forth between the red down sloping line and the blue up sloping line. I'll continue to wait for a clear sign.



Nothing-new here! More narrow bars trading right at the narrowing intersection of the red down sloping line and the blue up sloping line. I have a fancy term for these areas where two lines with opposite slope meet: I call them Energy Points. And over time, I've found that they act like a magnet to price and attract it-and these interactions with Energy Points tend to be key turning points in markets. When price gets to this Energy Point or area where lines of opposing force meet, maybe it will finally give us a strong sign where it's going!



Just as price enters the Energy Point area, it breaks below the blue up sloping Lower Median Line Parallel. And it closes well below the blue up sloping line, in the lower third of the wide range, with great separation. Not only did price take out several prior swing lows, it left a nice set of triple tops just above the red down sloping line. I can hide my stop loss order above these triple tops! So now I have a clear sign from price of its probable direction and a quality formation I can hide my stops above. If price rallies back to re-test the red down sloping line-which would be right at the Energy Point-I'll get short and put my stop loss order three ticks above the triple tops price just left. NOW I am ready to put my own money on a trade.



Price rallies and tests the Energy Point, getting me short in the process. My initial stop loss on the short trade is three ticks above the triple tops and my initial profit target will be at the red down sloping Lower median line Parallel. If price gives me a chance, I'll hide my stops above formations as it works its way lower, boxing in profits.



Once price tested the Energy Point from below and failed to break back above it, you can see it was a one-way move lower. If I had spent my cash and emotional energy getting long and short and long short during the congestion, I would probably have been emotionally bankrupt and lost a tidy sum of money. And when price finally did give a clear sign of where it was going, I would have probably been so frustrated I'd have passed on the trade.

There is a time for patience. It's often the hardest lesson for traders to learn but waiting patiently and listening to what the market is telling you will improve your trading success and profitability greatly.

I wish you all good trading!

Timothy Morge