Trading made simple: the ‘failure swing’
Failure swing occurs when there is an interruption of an existing trend and a start of a new trend. It is a strong indicator that the market will reverse. As seen in Figure 1, while the market is in a bullish uptrend condition there is a failure at point C for the market to overcome point A to make a new high. After the market breaks point B at point S then there is an indication that the market will reverse and a short (sell) position should be opened. Point C on Figure 1 should always be less than or equal to the top of point A. The opposite can be seen in Figure 2 when a failure swing bottom follows a bearish downtrend. When the market at point C is not able to indicate a new lower value than the low on point A then a long (buy) position signal occurs when the B level breaks at point B1.
The way to trade the failure swings is to measure the distance between point A and B and when point B breaks then the trader should try to take profit from the same distance the difference between A and B. The stop loss on the trade should always be a little above point C (or a little below if it is a bottom).
Figure 3 is an example taken from the daily graph of DAX (total return index of 30 major German companies traded on the Frankfurt Stock Exchange). The chart shows a real example during the summer of 2014 of a bullish uptrend followed by a failure swing and the market reversed to a downtrend. At point C (10037) the market was not able to indicate a new top and at level S (9749) the B point breaks indicating a short position. Opening a short position, the stop loss of the trade should always be a little above point C as mentioned which in this case is about 10050. The ‘take profit’ should be at the first TP on the graph at 9451 which is the difference from point A and B. The light blue lines in Figure 3 indicate this difference from point A and B and every time the market breaks the line then a short position should be opened for a take profit target in the next light blue line. If the risk and reward is not enough – since A and C is a double top and the risk and reward ratio is 1:1 – then the take profit target could be moved to the next TP level. So, in this case the short position should be opened at 9749 and the stop loss to be at 10050. The profit taken should be at the second light blue line because we want the reward ratio to be double the risk at 9153. If this failure swing was traded correctly on this example, a profit of 596 points would have been achieved.