Swing Charts – Part 2
In the previous article, we learned how to filter through all the price “noise” on our charts and find important highs and lows through the use of swing charts. We found out how each new swing that is plotted on the chart should have a minimum move in price. In this article we will see how each new swing should have a minimum amount of bars.
When we plot a swing chart based on price only, on occasion, we may notice an “outlier” or bar that doesn’t seem to reflect the recent the typical range of prices. This could happen for a number of reasons, one of which would be a temporary artificial manipulation in the market during low volume. If we used the above mentioned outlier bar when building a price only swing chart, we may find that the outlier bar will create a significant distortion. How do we solve this problem? By adding a rule that states that any new swings plotted on the chart have a minimum amount of bars. This additional timing element will filter out any outlier bars that create a swing that is , for example, one bar in length. What is the optimum number to use in regard to the minimum bar threshold? This is the $1,000,000 question. The best way to find the minimum amount of bars to define a swing is to look at the previous price history for the instrument in question. For example, let’s imagine we plot a zigzag indicator on a chart and the price sensitivity is set to 1%. Looking at the data over a number of years, there appears to be a distinct price rhythm that our zigzag indicator conforms to. Each of the swings that are greater than 1% in price appear to last 1-2 weeks. However, upon further examination, we find three unusual swings that don’t seem to fit. These swings conform to our 1% price rule but one is one bar in length, another is two bars in length, and another is three bars in length. As these swings appear to be unusual distortions, perhaps driven by a fundamental event, they should be removed from our purely technical chart. This can be done by applying a time filter that eliminates swings that are 3 bars or less in the above example. By applying this time filter on our swing charts we will be able to focus on the significant highs and lows to allow us to clearly see ABC corrections and allow us to find trend moves to draw Fibonacci retracements (covered in the next article).
Ross Beck, DMS, FCSI