There are many ways to make money in the stock market. You can buy shares in companies that offer a dividend, you can buy small companies that have just started out with loads of growth potential and you can buy shares in companies that have a had a big issue, the share price has fallen drastically and now they have to turn themselves around. Alternatively you can swing trade. In this blog I’m going to explain what swing trading is, how to spot it and how to use the rule of eights to maximum effect.

What is a Swing Trade

Before I answer that question let me recap on what day trading is. A day trader wakes up at 5.30 in the morning and by 7AM they are sitting at their computer terminal waiting for the Regulatory News Service(RNS) for the day. This is any news pertaining to the company that is required by the stock market to be offered to us investors for deliberation. Included in the RNS are items such as Board changes, Contracts won and lost, acquisitions of other companies etc. They start the day with only cash in their account and buy and sell all day long ( based on certain patterns in the share price movement) and by the end of the day they have no shares in their account, only cash. The difference between the cash balance at the start and end of the day represents their profit or loss.

Swing trading is the same principle but different. From time to time a companies share price becomes range bound. By that I mean it trades up to a certain high point and then trades down to a certain low point. For the life of me I have yet to work out why this happens but it does. `Let’s look at a few examples.

Swing Trading Rio Tinto

Here is the 6 month chart for Rio Tinto. We can see that the share price has risen 44% in that time and it has been steady. It doesn’t show us much else and it definitely does not demonstrate that this could be a swing trade opportunity. The share price has to oscillate high and low which this isn’t doing so let’s look at the 1 year share price chart and see if it show us any different pattern.

The 1 year chart gives us a little more information. It was bobbing up and down from April through to July and then it started climbing. But again it doesn’t really indicate that Rio Tinto could be a swing trade opportunity.

Looking at the 5 year chart however now reveals a definite swing pattern event occurring. Rio Tinto seems to bounce from 60 at its highest to 45 at its lowest. Drawing a line across the tops of the peaks shows us a price at which the traders are reluctant to push the price higher. This is where there is resistance to push the price higher. They start to sell pushing the price lower.

At the other end the support line shows the price at which the traders are happy to reverse the trend and start to buy again. The chart also shows us the rough timeline of these swings. Let’s have a look at another example.

Swing trading Knights Group

Here is the 1 moth chart for Knights group. Doesn’t tell you much except that the share price has gone from a high of £1.90 a share down to £1.55 ( roughly). Not very useful if you are looking for swing trade opportunities. However, looking at the 6 month chart the swing opportunity starts to itself

We can now definitely see a potential swing trade opportunity. The share price does seem to rise up to the £2 mark, then take a swing downwards to roughly £1.50 before it turns again. We just need more evidence that this is indeed a potential opportunity so let’s look at the 1 year chart for confirmation

We don’t have to go back 5 years to see the evidence. The 1 year chart will do just fine. By drawing support and resistance lines we can see that it has reached a high of £2 on three separate occasions and then it reverses and drops down to £1.50 is and It takes approximately 1 year to go from low to high to low again.

Rule of eights- Mitigating the risk

In the case of Rio Tinto the difference between its high and low swing represents a 33% potential gain which is a phenomenal return for 6 months. In the case of Knights group it’s roughly the same – about 33%. Of course you’ve more chance of winning the lottery if you think to can continually buy at the lowest point of the swing and sell right at the top so this is where we use the rule of eights. If you trade somewhere in the middle there’s a fairly good chance of making between 15 and 20% on each swing cycle which is not to be sniffed at.

Swing trading – Conclusion

I have no idea why certain company’s share price oscillates in this fashion. It could be as simple as people taking profits. Let’s face it, who isn’t going to sell if they’ve made in excess of 25%. Plus the fact in a world of uncertainty, certainty is king and if a company breaks the confidence of the professional fund manager ( in the form of a profit warning say) it takes time for confidence to be restored. This is the case for Knights group. They tentatively push the price up but get spooked at a certain level and start to sell. Then confidence comes back in at a certain price and the trend reverses. I’ve turned a tidy profit swing trading these two companies and will add to my watchlist when I come across other examples. All it takes is to check the historical charts and timelines and I’m sure you’ll agree they are fairly easy to spot. It isn’t an exact science so using the rule of eights mitigates your risk and helps you sleep at night. Oh, just two more things. The beady eyed amongst you will have noticed that Rio has just broken out of the swing by rising to over £73. Don’t kick yourself for selling at £57 say when you bought at £48. You’ve still made good profits and whenever you buy shares just go back in the timeline ( remember Rio only presented itself on the 5 year chart) and check whether it is stuck in a swing pattern. You might think it’s a good price but if the price on offer is towards the top of a swing it’ll only be reversing at some point.