This glossary captures terms relating to understanding swing trading of stocks. Many of these have associations with other contexts, but we will focus on stocks for the most part.
ADX. Average Directional Index. An indicator that is popularly used to determine whether a stock is trending or not. This indicator attempts to separate trending stocks from non-trending, or oscillating stock. The directional of the trend, if any, is determined by a different indicator, the DMI.
Bollinger Bands. An indicator that keys off the volatility of a stock’s price and tries to establish a rough measure for detecting when a deviation from the mean may have gone far enough. Not a reliable indicator of price reversal by itself, but is useful in conjunction with other indicators.
Buy-and-hold. The paradigm of investing in the stock market where you buy shares of a company with the intention of holding it indefinitely. This assumes that you have done a detailed fundamental analysis of the company and have decided that the investment is attractive for your lifetime. This is one extreme of stock trading strategies where there is no exit. This contrasts with market timing strategies that rely on technical analysis of the company stock to determine entry and exit criteria for trading it. [See also Market Timing]
Cash account. A type of brokerage account where no borrowing of funds or securities from the broker is authorized. Securities are bought with the funds that the trader previously added to the account, and they are sold to add the proceeds to the account. Alternately, the trader can deposit previously owned stock certificate with the broker and use it to make future sales of the securities. [See also Margin Account]
Day Trading. A very short term trading strategy where securities are bought and sold on the same day. Taken to the extreme, the day trader may start the day in all cash, go through the day with multiple trades each lasting a few minutes or hours, and closing out all positions before the trading day ends, restoring the all cash position. [Read more]
DMI. Directional Movement Index. An indicator pair, +DMI and -DMI, that establish the direction of any trend present in stock price. Each bounded between 0 and 100, these two indicators measure the strengths of bulls and bears individually, and indicate the trend direction depending on which reads higher. A higher +DMI than -DMI indicates a bullish trend and the converse indicates a bearish trend.
Efficient-market Hypothesis. (EMH) Directly contradicting the principles of technical analysis, EMH claims that future prices cannot be predicted based on past prices and volume. Economist Eugene Fama famously published a paper to this effect in 1970, claiming inadequacy of technical trading in offering profitable trading scenarios. EMH has come under criticism since from technical traders that some of the assumptions made by that model are not valid in the real world. The debate continues, and our intent is to experiment with technical analysis to demonstrate the feasibility of extracting profitable trading strategies. [Read more]
Exponential Moving Average. A calculation of moving average where more recent historic prices are given higher weight than the older ones and the weighted mean of those prices forms the moving average. [See also Simple Moving Average]
Fibonacci. An Italian mathematician, credited with being the most talented mathematician of the Middle Ages. His discovery in a sequence of numbers and their interrelationships play an important part in several aspects of life as we know it. Of special significance in stock trading are the Fibnacci Retracement and Fibonacci Extension. [Read More]
FINRA. Financial Industry Regulatory Authority. An independent, self-regulatory entity whose charter is to protect the general public by overseeing securities dealers and brokers for integrity. [Read More]
Forex Trading. Purchase and sale of currencies in the foreign-exchange market. This is done with a view to exploiting fluctuations in the currency exchange rates for profit. [Read more]
Fundamental analysis. This is the methodology to determine the “real” value or “Fair market” value (FMV) of a stock. This approach takes into account a variety of factors that affect the underlying company’s business and attempts to pin down a specific number for what the stock price should be. If the market price for the stock is lower than this FMV, then the stock is undervalued. If they are equal, then it is fair valued. If the market price exceeds the FMV, then it is overvalued. Undervalued companies are attractive buys and overvalued companies may be subject to a “sell” recommendation. [Read more]
MACD. Moving Average Convergence/Divergence. This is a trending indicator that shows the direction of the trend, its intensity, and also the strength of buyers and sellers. Industry standard MACD plots the difference between the 12-day and 26-day EMA plots of the stock. The use of this indicator involves a 9-day moving average of this indicator plot and the difference between the two expressed as a histogram!
Margin account. A type of brokerage account that permits a trader to engage in leveraged security transactions, including short selling of securities. Being able to borrow funds or securities from the broker is the hallmark of a margin account. This introduces the possibility of a margin call whereby the broker requires additional funds to be added to the fund due to market conditions. [See also Cash Account]
Market Timing. The paradigm of stock trading where there are defined criteria for entering and exiting specific stocks, with no particular goal of long term investing. Typically, strategies for market timing are based on historic price and volume action on the market of the underlying stock, and may include some fundamental analysis as well. The cycle may have a buy to open a long position, followed by a sell to close it out; alternately, it may have a sell to open a short position (see Short selling), followed by a buy-to-cover to close it out. This is in contrast with buy-and-hold strategy where stocks are purchased and never (or seldom) sold. The time horizon for market timing ranges from extremely short (day trading) to short (swing trading) to intermediate (position trading). [See also Buy-and-hold]
Moving Average. Often referred to as MA, this is the average share price of a stock for the past number of trading periods. The number of periods over which this average is computed can be varied and is one aspect of experimentation. Moving average can be computed for any of the prices of a stock: open, high, low, or close. While analyzing daily charts, the periods are days; for weekly charts, they are weeks; for monthly charts, months. The moving average often is an excellent tool to gauge the trend of stock movement and is used heavily in technical trading. [See also Simple and Exponential moving averages] [Read More]
Non-trending Indicator. A technical indicator that should be used when a stock is non-trending (in other words, oscillating).
Non-trending Stock. A stock whose price is oscillating, and not trending. In other words, does not show a tendency to rise or fall in successive time periods (days, weeks, or months) but oscillates between two price points.
Options Trading. A type of derivative trading, buying and selling rights to buy and sell underlying securities. Normally applied to stocks as the underlying security. Specifically, an option in this context refers to the right to buy or sell a block of 100 shares of the underlying stock at a specified price (strike price) within a time frame with a specified expiry date.
Pattern Day Trader. A FINRA classification to identify frequent day traders. A Pattern Day Trader (PDT) is one who completes four or more day trades in a span of five days. Once designated as a PDT, the trader is required to maintain $25,000 equity in the margin account to continue to day-trade. In turn, the margin requirement is relaxed to 4:1 from the usual 2:1 for margin accounts. If the portfolio drops below $25K in cash and securities, no further day trading is permitted until the account is brought up to $25K or more in value. This regulation is prescribed by FINRA and enforced by the brokers. It is designed to prevent excessive trading by inexperienced traders. [Read More]
Personal Finance. A broad topic of importance to individuals in managing all aspects of their income, expenses, savings, debt, and investment. The full extent of this topic is outside the scope of this site. A thin sliver of it–swing trading of U.S. stocks for individuals–is our focus. To properly situate swing trading among the alternatives for individuals, we may touch upon various subtopics of personal finance in different contexts. [Read more]
Position Trading. A type of market timing strategy where stocks are traded to exploit trends detected in their prices. The crux of this strategy is to enter the trade when a trend is detected and exit it when the end of that trend is detected. There is no preferred time horizon for this trade cycle and it can (and usually does) extend much longer than swing trades. These trades last often weeks, months, or even years before they are closed out. Only buy-and-hold investing has a longer time horizon. [Read more]
RSI. Relative Strength Index. This non-trending indicator measures the relative performance of a stock as compared to itself! Range-bound between 0 and 100, RSI indicates whether a stock is oversold (when it is below 30), overbought (when above 70), or neither.
Rule of 72. A rule of thumb often used to estimate the time it takes to double an investment that compounds all its returns over time. [Read more]
Short selling. Selling shares that are borrowed (typically from the broker). Such shares are restored to the lender by buying them at a later time and closing the open short position with the broker. This type of transaction requires a margin account. Short sales are used when the trader expects the price of the stock is expected to go down.
Simple Moving Average. A calculation of moving average where all the historic prices are given equal weight and the mean of those prices forms the moving average. [See also Exponential Moving Average]
Stock Options. The rights to trade stocks of a company at a future date at an established price. As a rule, such options are time-limited, and expire at the end of this limit. Two major categories of stock options are: exchange-traded stock options and employee stock options. Employee stock options are designed to let employees share in the performance of the employer as an incentive. Exchange-traded options are traded on a securities exchange and are available to anyone willing and able to participate in such trades. Due to the speculative nature of these options, the interested trader needs to have a margin account that is specifically approved for options trading by the broker.
Swing Trading. A short term trading strategy where securities are bought on one day and sold on a different day. Normally, the closing transaction is one day to a few weeks after the opening transaction. Applies to both long (buy and then sell) and short (sell borrowed shares and buy to return the shares) positions. Except in rare instances, the transaction pair does not happen on the same day.
Technical analysis. Applied to trading in the stock market, technical analysis is a methodology of interpreting the history of trading data–price and volume–to predict future trends of prices. Short term trading in the form of day trading, swing trading, and even position trading to some extent are based on the assumption of applicability of technical analysis to the stock market. This model contrasts with the Efficient-market Hypothesis which considers the market to account for all known information at all times. [Read more]
Trend Indicator. An indicator that establishes whether a stock is trending or not. ADX, the Average Directional Index, and DMI, the Directional Movement Index, together determine whether the stock is trending up, trending down, or oscillating.
Trending Indicator. A technical indicator that should be used when a stock is trending.
Trending Stock. A stock whose price is trending. In other words, shows a tendency to rise or fall in successive time periods (days, weeks, or months). Contrasted with non-trending stock whose price oscillates between two price points.
VIX. Volatility Index. This is a measure of how volatile the market as a whole behaves at any given time. Higher VIX implies wider price swings in securities.