Build a Complete Swing Trading System | The Long & The Short Ep. 44

Welcome back to the part three of our series on swing trading. In part one, we covered what swing trading actually is, where the word comes from, and the seven different ways to identify a swing. In part two, we got into stock selection using two of those methods, six and seven, finding the strongest stock inside the strongest sector and the strongest category more broadly. Since that episode went out, a lot of you wrote in saying you've gotten a hang of that approach and wanted to know more about the other methods we had mentioned back in part one. So today, I'll touch a bit on that and walk through how you can use some of those other methods specifically for stock selection. But more importantly, we'll cover a very simple systematic approach to select stocks and rebalance them as you go. You see over the years what I've realized is that more than stock selection which I think is the easier part what's more important is timing the whole strategy of swing trading and being systematic about capital allocation and exits. And once we have all those aspects in mind, it becomes a lot more easier to swing trade systematically over the long run. I'm your host Sepra and with that let's get started. Before I start, here's a quick disclaimer. The examples and ideas shared in this episode are strictly for educational and illustrative purposes only. Nothing discussed here should be construed as a recommendation, investment advice, or a solicitation to trade. Trading in stocks and derivatives involve significant risk and can result in complete loss of capital. The examples and data presented are meant to explain market behavior, not to suggest that similar outcomes will occur in the future. Before we get into anything, I want to share something which is of fundamental importance when it comes to swing trading or any trend trading for that matter. When I started trading, a lot of articles and books used to say be in sync with the market. As a novice or a beginner, that whole idea of being in sync didn't make sense to me at all. No one told me what being in sync actually means. It was only much later that I realized the meaning and the value of being in sync. Especially when it comes to swing trading in stocks, it becomes important that we look at what the underlying market or the underlying universe is doing. Let's say your filters have selected midcap stocks. So in that light, it's good to see what an index like midcap 150 is doing. [music] Likewise, if it's a small cap or a micro cap, it's good to see what the collective of small caps and micro caps are doing through any of those indexes. The idea is to have some kind of a trend filter on the base index so that you don't trade when the larger trend in that category is negative. For instance, you can plot these charts and use that as a reference. Let's say you're doing this on a daily time frame. you may use something like a 21-day or a 50-day moving average. If the index goes below that, you don't do swing trading in any of the stocks belonging to that index because the odds of trends forming in any of the underlying stocks in such an environment are quite low. It's pretty much like they say a rising tide lifts all boats and that's exactly what we want a rising tide so that we can be with it on the right kind of boats. Let's now look at how to actually identify these swings on a chart especially using methods 1 through five which we spoke about in part one. In part one I started with Perry Kaufman's swing charts which are conceptually similar to PNF or point and figure charting. For our strategy though we are going to use Renco charts. They are far easier to understand and serve the exact same purpose of filtering out market noise. As you can see on this chart, we have set our Renco brick size to 5%. This means a new green block only prints when the price rises a full 5% from the previous block. Similarly, a red downtrending block won't form until the price falls 5% from its previous close. Because Renco only cares about price movement, it completely compresses time. Look at the comparison on your screen. We have the Renco on top and the standard candlesticks on the bottom. The thing with candlestick charts is that it's forced to print a new bar every single day, creating a crowded chart even when the market is flat. Renco compresses years of sideways action into a tiny clean space and it only prints when there is actual progress. So, how do we use this to trade? As a general framework, you would wait for a green block to form or ideally two blocks to confirm the change in the trend before you make any entry. Simultaneously, you run your category filter. Make sure the stock's broader sector or market cap index is trading above its 21-day moving average. Now, don't treat these specific parameters as rules carved in stone. They are simply a reliable structured framework to ensure you are entering a stock only when both its immediate swing and its broader universe have a strong tailwind. The next entry method which I also touched upon in part one is the end day breakout. You can use any look back period that fits your style. Though 7, 15 or 21 days are common standards. The logic is incredibly intuitive. The system tracks the highest high and the lowest low of the last 10 days. If the price closes above the highest high of that period, you have a valid bullish breakout. Conversely, if it breaks below the lowest low, it's a bearish breakout. There are dozens of free and built-in indicators on Trading View that identify this for you. All you have to do is plug in your preferred look back number. Here's an example of one such breakout on a chart. Now, remember the golden rule we established earlier. An endday breakout is simply your entry trigger. you only pull the trigger if the stock's broader market sector or category index is aligned and showing a strong tailwind. The third method I want to highlight today is a classic chart pattern we explored in part one flags and penance. While these are traditional price patterns, you don't necessarily have to spot them manually. Trading View has a built-in indicator that can automatically detect and plot them on your screen. As you can see on this chart, you can change the settings to quantify what according to you counts as a flag or a penant. The trading logic here is pure breakout trading. A close above the upper boundary of the flag or the penant triggers a long entry while a close below the lower boundary indicates a short entry. The system identifies both bullish and bearish variations of a setup. But the exact same rule applies here. A flag or a pennent breakout is simply a localized entry trigger. You only take the trade if the broader breadth of the sector or the market cap category is fully aligned and moving in our favor. So far we've covered the three individual stock entry methods we introduced in part one of this series. Now let's move to understanding a systematic portfolio approach to swing trading which would mean position sizing and diversification all included. At a broad level the strategy is this. We maintain a hard cap of five concurrent open positions at any given time while you can scale this to 10 using five means a clean 20% capital allocation per trade. Now obviously this is one of the approaches to size. There are many. When you're trading this strategy for the first time and when you're starting out, you run the scans using a fixed set of metrics to identify qualifying stocks. [snorts] And then you allocate to all the stocks that qualify for you. Say you start with five positions where all the five stocks qualify your criteria. You then operate on a strict onein oneout rule. If your portfolio is full, you cannot add new trades. The moment an existing stock from your five stock portfolio hits its exit trigger and frees up capital, you run the scan again to figure out or find the next best strong candidate to fill in that empty slot. Finally, remember that each position is managed by its own independent trailing stop or exit logic. There are no fixed profit targets and no fixed holding periods. You simply let the trend run until the trailing mechanism tells you it's time to exit. To scan stocks, I personally use a Trading View scanner with a simple percentage change rule. As you can see on the screen, it looks a bit like this. Essentially, I look at the top performing stocks over the past 1 week period, and the scanner automatically ranks them by relative strength. That becomes your core basket of stocks. From there, you can choose to doubleclick on individual names to identify specific technical patterns or you can simply take the top performing ones as they are. If you want to tighten the selection, you can layer on top of it an extra trend or liquidity filter such as the stock should be above its 200 day or 50-day moving average. Plus, it should have a specific minimum average volume. While I use Trading View Premium for this, but that doesn't mean you have to. There are plenty of third-party scanning tools out there that you can use for the exact same job. What matters more is sticking to the core method. While this approach is highly systematic as it relies on fixed criteria, you can absolutely add a layer of personal discretion to the final stock selection if you would like. And if you don't want to use discretion, you can blindly execute it as a pure rules-based system. Both approaches actually work fine. As always, keep in mind that this is just a broader framework. I'm not saying this is the exact set of parameters that you have to use. You can tweak the look back periods or moving averages to fit your style. As long as you stick to the core principles of this broad structured framework, you should be good. So far we've covered the various ways of identifying entries and we've touched briefly on the idea of trailing your positions as well. Now I want to categorically break down the different methods of trailing stop-loss and exits you can implement to protect your capital and lock in your gains. The first approach is using a simple moving average. Typically done on the daily time frame. You can use a 21-day moving average to give the trade some breathing room or tighten it up to 9day or 7-day moving average if you would want to trail closely. Now, personally, I prefer using EMAs, which is exponential moving averages because they react much faster to recent price action. The second approach to use is an indicator like super trend. The main advantage here is that Super Trend incorporates the average true range ETR, meaning it dynamically adjusts for market volatility far better than what a standard moving average does. And the third method is using a fixed trailing percentage from the highest point the stock reaches. As the price climbs in your favor, your stop loss automatically moves upward, maintaining a strict buffer of say 3 or 4% below the peak price. The moment it drops below that fixed percentage from the high, you are taken out and you exit the trade. As you can see on the chart, I have plotted all the three approaches side by side. You can pick whichever works the best for you. But the golden rule here, however, is about being consistent. Select one method that fits your risk tolerance and stick to it rather than messing around and switching indicators mid trade. Now that we've covered our exit rules, the next critical pillar of this system is position sizing. Broadly speaking, there are two distinct ways to size your trades. The first is equal allocation, which we touched upon earlier. If your swing portfolio is capped at five stocks, you simply deploy an identical 20% chunk of your total trading capital into each position. The second method is riskbased position sizing. Because every entry setup we discuss has a predefined technical exit point, you can calculate the exact rupee distance to your stop-loss before you enter. From there, you work backwards. If you want to risk, say 1% of your total capital on a single trade. That stop-loss distance dictates exactly how many shares you are allowed to buy. For example, suppose you have a 10 lakh portfolio and you're willing to risk 1% on a trade. That means your maximum loss is 10,000 rupees. If you're buying a stock at 500 and your stop loss is at 480, your risk is 20 rupees per share. So your position size would be 10,000 divided by 20, which comes to 500 shares. [music] If the stop loss is hit, your loss is limited to just 10,000 rupees regardless of the stock's price. Now, irrespective of which method you choose, being disciplined with your capital is absolutely important. Never exceed the total capital pool you have dedicated to your swing trading system. It shouldn't happen that one week your five positions are taking in five lakhs and the next week you jump to seven lakhs just because you feel you should be aggressive. Consistency in your baseline capital is what allows the math of trading to work in your favor in the long run. If you want to scale up or alter your overall capital allocation, do it gradually over time as your account size grows rather than making abrupt random changes from one trade to the next. Another important principle is to look for trades with a favorable risk-to-reward ratio. Ideally, I would say 1 is to three. In other words, if you're looking at risking one rupees, it should have the potential to make at least three or more. This is especially important in systematic trading because losing streaks are inevitable, and it's not uncommon to have several stop- losses hit around the same time. A high riskreward ratio ensures that a handful of winning trades can more than offset multiple stop- losses, allowing the strategy to remain profitable over the long run. Using trailing stop- losses in a way helps you with the same approach as some trades may give you way more than 3 is to one and there are others which won't. Lastly, I want to talk about an approach that rarely gets discussed in mainstream swing trading circles and that is swing trading a basket of exchangeraded funds or ETFs rather than individual stocks. Trading ETFs offers a couple of major strategic advantages. First, they are inherently far less riskier than individual stocks because they filter out single company overnight risks and severe gap downs. Second, and what I like about ETFs is they open up a universe of asset classes well beyond equities, allowing us to easily swing trade gold, silver, and even US index ETFs. The beauty of this variation is that the entire system remains exactly the same. The entry methods, the trailing exits, scanning routine, and the allocation frameworks don't change at all. You are just applying the same methods to a basket of ETFs instead of a list of stocks. It's a great option worth exploring if you want smoother equity curves and lesser risk. In all probability, I'll record a dedicated fulllength episode on how to build an ETF swing trading system, but at the moment, it's something you should start thinking about, too. When it comes to ETFs, there's one major word of caution though. Stick with only those ETFs which have considerable volumes or ones which are liquid. There are many ETFs from many MC's which are just for namesake and not much of an activity happens in them. So you got to avoid those ETFs. So yes, that brings me to the end of this last episode in the swing trading series. And I hope you found this useful. If you have any questions, feel free to ask them in the comments. and I will try my best to answer them. Thank you. Until then, take care and trade safe. I'll be back soon with the next one.