Using a Narrow Range Scan to Find and Possibly Enter Swing Trades

The amount of time a swing trader spends in front of a trading engine entering or managing specific trades is dwarfed by the amount of time that trader spends researching and analyzing trade setups while the market is closed.  Effective swing trading takes a significant amount of time and effort, so any tools we can use to reduce the manual portions of the job are extremely beneficial.

Fortunately, for the 21st century swing trader, there are numerous online sites that assist in scanning for trade candidates.  Some are free (or sort of free) like Finviz.com or Chartmill.com, whereas others such as Stockcharts.com offer subscriptions but far greater scripting flexibility to search for desired trade setups.  Personally, I use all three of the sites I've listed since each has a unique approach and each is capable of identifying stocks that are suitable for the watch list.

What the swing trader learns in their first year or so is that there is no magic setup, nor is there a magic indicator that will guarantee the stock will move in the direction you anticipate.  Some setups and indicators will improve our probability of success, however in the end, it all comes down to our own ability to read the hidden market psychology being revealed by the charts and indicators tightly coupled with our own discipline in managing risk, managing our capital, and determining the entry and exit points that meet our own style and risk tolerance. 

The setups that I trade naturally change as market conditions change.  The market is a very dynamic and moody beast with numerous personalities.  The setups that are working well in this post-election market exuberance period (which, for me, are momentum and breakout plays) will not work well once the market either consolidates or corrects in the post-inauguration period.  We'll need to adjust and determine what strategies to implement when we see the market's mood at that point.

One type of scan I use to identify opportunities in most market conditions is a Narrow Range scan.  The details of the theory behind the narrow range, along with several trading strategies that employ it, are covered in excellent detail in "The Master Swing Trader" by Alan S. Farley. (Farley, A. S. (2001) The Master Swing Trader - Tools and Techniques to Profit from Outstanding Short-Term Trading Opportunities, McGraw-Hill, New York, NY.)

If you use Stockcharts, you may paste this scan directly into the advanced scan engine:

[type = stock] AND [country = US] AND [sma(63,Daily Volume) > 1000000] and [[exchange is NYSE] or [exchange is Nasdaq] or [exchange is Amex]]

and [Close >= 25.00]
and [Close < 100.00]

//
//  This scan finds stocks that demonstrate an NR7 pattern.
//

# See if today's range is the smallest in the prior six days.

and [today's range < yesterday's min(6,range)]

# Check for trending prior to entering the range.

and [7 days ago adx line(14) >= 30]

and [
[group is ConsumerStaplesSector]
or [group is CyclicalsSector]
or [group is EnergySector]
or [group is FinancialSector]
or [group is HealthCareSector]
or [group is IndustrialSector]
or [group is MaterialsSector]
or [group is TechnologySector]
or [group is UtilitiesSector]
]

It's important to understand that we do not automatically enter a trade simply because the stock has drawn the narrowest range of the last seven days.  The scan simply returns a list of candidates for further analysis.  From there, we need to analyze the chart to determine if there is a potential move imminent, and if so, whether or not the risk vs reward is worth the trade.  From there, we need to determine how best to play it.  Let's look at one that popped up on the scan, today.

DXCM Daily Chart

Dexcom, Inc. (Nasdaq: DXCM) started a decline on 28 September 2016.  It has either completed a truncated 5th wave in that decline, or it's in what will be an extended Wave 5.  Which way that plays out, we don't yet know.

We can see that, following the low on 3 November, DXCM retraced 38.2% of the full impulse before declining back almost to the full extent of the downtrend.  At a fairly pronounced support level, we can see that DXCN entered a consolidation period, balanced neatly between a strong support line and a strong resistance line.

That bit of congestion culminating in a narrow range day is precisely what we're looking for.  It's the type of situation that Farley refers to as a "coiled spring."  The odds favor a short but explosive move.  The challenge, though, is we really don't know which way the move will go. 

You can see on the chart that I've highlighted two target areas in green.  A move to the upside will likely penetrate the area topped by that prior consolidation region.  A move to the downside will likely run into some congestion where the prior decline stalled. 

One of the methods Farley mentioned in trading the Coiled Spring is to place a buy opening stop above the high of the narrow bar and a short sell opening stop below the low of the narrow bar.  You'd set this up as a single trade with a "one cancels all" order, so whichever one triggered would automatically cancel the opposite trade.  It's a low risk setup in that the protective stop - set to the same level as the opposing open level - is very narrow.  We're not risking a lot of capital.  What we do risk, however, is being stopped out almost immediately due to intra-day volatility. 

To mitigate the intra-day risk, I prefer to set a start-time of 10:01 EST on the trade.  This, at least, keeps us out of that first 30-minutes where wild swings are the norm.  A second mitigating technique I'll use is to set another condition on the opening order such that the overall market must be moving in the same direction as the stock.  This avoids us having to swim into the current if the stock moves contra-market for a period of time. 

Once in the trade, we'll manage the overall play very closely.  This is a short-term explosive setup, so we expect to be in the trade for 2 or 3 days at most.  We need to watch how the stock behaves as it approaches either of the diagonal support or resistance lines marked in green.  At the first sign of weakness, we're out.  There are also three significant moving averages that are hovering over us to the upside.  Any of those could act as resistance, as we saw between 10 October and 11 November with the stock constantly bouncing off the 10-day moving average.  Again, at the first sign of waning momentum, we need to exit the trade.  This is a setup for a quick profit, not a home run.

One final note on this type of setup.  Don't be afraid to immediately take the opposite position if stopped out quickly.  In this type of chart setup, the initial move is likely to be short and swift.  There is also decent profit potential on the reverse move after we're stopped out of the position.  That's a difficult trade to enter psychologically, but it's one I highly recommend considering. 

Happy Trading.