Since the April 22 follow-through day, we've mostly seen a strong trend in market indexes. The Nasdaq composite had a stretch above its 21-day that put it in the 99th percentile for length of time without a break below the line. But August has seen a change in character. Here is how our swing trading strategy handled the change.
Watch The 21-day Line For Trends
The Nasdaq composite moved above the 21-day line back in April and hardly looked back. After a brief pullback to the line on June 23, it immediately found support and continued the trend (1). With swing trading, that's certainly a trend worth leaning into, but there's no excuse for complacency.
We spent quite a bit of time on margin for the model portfolio of SwingTrader but used cues like downside reversals (2) to reduce exposure. In those cases, rebounds from the 10-day line happened quickly and our reduced exposure quickly ramped back up on the bounces.
As we started getting extended, however, we shifted exposure. On July 28, we saw what looked like stalling action (3). The rate of ascent was slowing down and we were well aware of how far indexes had come without a test of support. Since we typically do some selling into strength, that naturally reduces our exposure, especially when we can't find any new setups to replace the sells. The end result was that we were off margin by the end of the day on July 28.
How To Reduce Drawdowns With Swing Trading Strategy
A previous column showed how reducing drawdowns is a swing trading superpower. As we got more dramatic downside reversals (4), we again used the market cues to lighten up our exposure. The result? We were only 31% invested in the model portfolio the day before the first gap below the 21-day line in months (5). Even with the reduced exposure we were down 0.75% for the day, but that was half the drop of the S&P 500 and a third of the drop of the Nasdaq composite.
While we might reduce exposure with the expectation of further weakness, we never know how long that weakness will last or how bad it will get. Therefore, it is prudent to be open to increasing exposure if the market action dictates. In this case we found ourselves back on margin within a week as the Nasdaq composite got back to highs.
Still we were looking toward the exits, especially as we saw more stalling action and the power trend going under pressure (6).
Recognizing a change in character, we had lightened up to only 31% exposure for the swing trading model portfolio by Aug. 18 (7). Again, that saved us from taking a big hit the next day (8).
Just as the downside reversals tell us to reduce exposure, upside reversals tell us the opposite. With the Aug. 20 upside reversal (9), we started increasing exposure back up and as a result were able to participate in Friday's big rally.
It might seem like a lot of work and volatile action, but the end result is a reduction in portfolio volatility by reducing drawdowns.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
