Swing Index – Rules, Strategy, Backtest, Returns

For short-term traders, the right trading tools are ones that help them quickly spot shifts in the momentum and price swings — this is where the swing index indicator may come in handy. What do you know about this trading tool?

The Swing Index indicator is a momentum oscillator that tries to find the actual price of an asset by comparing the current price data points — the open, high, low, and close — to the previous period’s price data points. Useful for very short-term trading, the Swing Index is the primary component of the Accumulative Swing Index, which is a cumulative version that is used for determining price trends.

In this post, we will take a look at most of the questions you may have about the swing index: what it is, how it works, and how you can improve your trading strategies with it. Let’s dive in!

Key takeaways

• Purpose: The Swing Index is a momentum oscillator designed to estimate the “true” price of an asset by comparing current and previous period price data (open, high, low, close).
• Short-term Focus: Utilizes data from the last two periods, making it useful for predicting short-term price swings and aiding in very short-term trading.
• Developed by Welles Wilder: Created by renowned analyst Welles Wilder, it aims to identify changes in market behavior, showing shifts from bullish to bearish dominance and vice versa.
• Accumulative Swing Index Component: Serves as the basis for the Accumulative Swing Index (ASI), which tracks price trends cumulatively to indicate trend direction and strength.
• Signal Generation: Provides buy signals when crossing above zero and sell signals when crossing below, helping traders identify potential swing changes and shifts in market sentiment.
• QuantifiedStrategies.com backtests a Swing Index trading strategy. We also backtest the Accumulative Swing Index.
• More indicators are available if you click here: best technical trading indicators.

What is the Swing Index indicator?

The Swing Index indicator is a momentum oscillator that tries to find the actual price of an asset by comparing the current price data points — the open, high, low, and close — to the previous period’s price data points. Given that it only makes use of the last two period’s data, the indicator is used to predict future short-term price swings, which makes it a useful tool for very short-term trading.

Developed by the famous Welles Wilder, the Swing Index helps to spot the moments when market behavior changes, as shown by the changes in the direction of price swings. That is, previously dominating bulls become weaker, giving way for bears to dominate, and vice versa.

The indicator is the primary component of the Accumulative Swing Index, which is a cumulative version of the Swing Index used for determining price trends. Its objective is to measure the direction and strength of price changes in short-term price swings.

This helps short-term traders identify potential swing changes and market sentiment shifts. It gives a buy signal when the indicator line crosses above the zero line and a sell signal when the indicator crosses below the zero line.

In the lower pane in the chart below, you will find an example of the Swing Indicator on a chart:

How does the Swing Index measure price movement?

The Swing Index measures price movement by comparing the current price data points — the open, high, low, and close — to the previous period’s price data points, taking the difference and combining the values. This creates an oscillator that can spot moments when short-term price swings and momentum changes.

As an oscillator, the indicator’s values range from -100 to 100. That is, for up price movements, it ranges from 0 to 100, and for down price movements, it ranges from 0 to -100. When the indicator line moves from negative values to positive values — crossing above the zero lines from below — it means that there is a bullish short-term price swing. This could be a buy signal for short-term traders if the market condition is suitable.

In the same way, when the indicator line moves from positive values to negative values — crossing below the zero lines from above — it means that there is a bearish short-term price swing. This could be a sell signal for short-term traders if other market conditions are suitable.

Swing Index trading strategy – rules, settings, and returns

Let’s backtest a trading strategy that has the following trading rules:

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(Please look at the code below if you are unsure of the trading rules.)

There are very few trades.

The table below shows the returns if we sell N days after entry (including 0.03% commissions for each trade (0.06% for a round trip)):

There are very few trades.

This is the code we used for the backtest (Amibroker):

THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES

Who created the Swing Index?

The famous J. Welles Wilder Jr created the Swing Index in 1978 to evaluate how the price changes direction and price strength relative to price swings. A renowned technical analyst, he introduced the indicator in his seminal book “New Concepts in Technical Trading Systems“, where he also described the long-term cumulative version, the Accumulative Swing Index (ASI). In the same book Wilder also revealed the much more popular RSI indicator.

Wilder is an American mechanical engineer turned full-time market trader and researcher. He is well known in the trading community for creating many other popular indicators, such as the Relative Strength Index (RSI) and the Average Directional Index (ADX). Wilder once said:

“Somewhere amidst the maze of Open, High, Low, and Close prices is a phantom line that is the real market.”

What are the key components of the Swing Index?

The key components of the Swing Index are as follows:

• Yesterday’s price data: These include the open, low, high, and close prices. They are compared with each other and the various price data of today to get the various differences used in the calculation of the indicator.
• Today’s price data: All of today’s price data, such as the open, low, high, and close prices are used in the Swing Index calculation. They are compared to the previous day’s price data, and certain differences are used to calculate the indicator.

How does the Swing Index help in trading decisions?

The Swing Index helps in trading decisions by showing the direction and strength of price changes in short-term price swings. This helps short-term traders identify potential swing changes and shifts in market sentiment so they can take advantage of short-term trading opportunities.

The indication is most useful for making scalping and day trading decisions. On a higher timeframe, it can also be used to get in and out of quick swing trades. It gives a buy signal when the indicator line crosses above the zero line and a sell signal when the indicator crosses below the zero line.

What is the purpose of the Swing Index formula?

The purpose of the Swing Index formula is to measure the direction and strength of price swings. It does this by comparing the relationships between the current price data — open, high, low, and close — and the previous period’s price data. W

ith that, the formula calculates the differences between those data and uses them to estimate potential trend changes and market sentiment shifts. It shows a positive reading when an upswing is emerging and a negative reading when a downswing is emerging.

How is the Swing Index calculated?

The Swing Index is calculated using the following formula:

Swing Index = 50 ×{ [(Cy – Ct) + (0.5 × (Cy – Oy)) + (0.25 × (Ct – Ot))]/R} × K /T

Where:

Oy = Yesterday’s Open

Ot = Today’s Open

Cy = Yesterday’s Close

Ct = Today’s Close

T = the maximum amount of price change for the day

K = The larger of (Hy – Ct) and (Ly – Ct)

Hy = Yesterday’s high

Ly = Yesterday’s low

Lt = Today’s low

Ht = Today’s high

R: Varies based on the largest of the following:

Ht – Cy: Today’s High minus Yesterday’s Close

Lt – Cy: Today’s Low minus Yesterday’s Close

Ht – Lt: Today’s High minus Today’s Low

What timeframes work best with the Swing Index?

The timeframes that work best with the Swing Index will depend on your trading style and backtesting results. Generally, the swing index is used for short-term trading, and as such, it will work best in day trading and scalping. These trading styles are carried out on intraday timeframes, such as the hourly, 30-minute, and 15-minute timeframes for day trading and the 5-minute to 1-minute timeframe for scalping.

To know the timeframe that works best, you will need to backtest the various intraday timeframes to find out. Also, since price swings occur in every timeframe, the indicator can be used for swing trading on the daily and 4-hourly timeframes if backtesting results show that it offers an edge on those timeframes.

How can beginners use the Swing Index effectively?

For beginners to use the Swing Index effectively, they have to first learn how the indicator works and be able to create some simple trading strategies with it. The next thing will be to open a demo account with a broker and practice their strategy with paper trading.

When they are sure they have learned how the indicator and the financial market work, they can backtest their best strategies to find the ones with the best edge.

What signals does the Swing Index generate?

The signals the Swing Index generates include:

• The zero-line crossover signal: This signal is generated when the indicator crosses above or below the zero line — in other words, when it shows a positive or negative reading. When the indicator crosses above the zero line, it gives a buy signal if the market condition is suitable (a rising market). Conversely, when the indicator crosses below the zero line, it gives a sell signal if the market condition is suitable (a falling market).
• The divergence signal: This occurs when the price swing and the indicator swing are out of phase. A bullish divergence signal occurs when the price is making a lower low but the indicator is making a higher low. On the other hand, a bearish divergence occurs when the price is making a higher high but the indicator is making a lower high.

How does the Swing Index predict market trends?

The Swing Index predicts short-term market trends by measuring the difference between the current period’s and the preceding period’s open, low, high, and close price data. It uses these differences to estimate advances or declines in price, which show the direction of the immediate price swings.

When the indicator is showing positive readings — meaning the indicator line is above the zero line — it suggests an upward price swing. On the flip side, when the indicator is showing negative readings — the indicator line is below the zero line — it suggests a downward price swing.

Can the Swing Index be used in all markets?

Yes, the Swing Index can be used in all markets because it is calculated based on price data alone. It can be used in stocks, bonds, futures, forex, and even crypto markets — as long as the market shows the changes in price data in real time, the indicator can be used.

However, the goal should be to identify short-term price swings, as the swing index can only be used for short-term trading. Only a backtest can reveal the best markets and the best settings.

How does the Swing Index compare to other technical indicators?

Compared to other technical indicators, the swing index is a momentum oscillator that focuses on very short-term price moves. As such, it is used for very short-term swing trades, unlike trend-following indicators that can be used for long-term trends.

The swing index uses only two price bars in its calculation — the current and the preceding bars. So, its signals are just for taking advantage of quick price changes. This is unlike some momentum oscillators like the MACD, which uses up to 26-period bars in its calculation.

What is the relationship between Swing Index and volatility?

The relationship between Swing Index and volatility is that the indicator is very prone to volatility changes, given its very short-term focus. The index focuses on the price data of the most recent 2 price bars, so any changes in volatility have undue effects on the indicator. Whether this is a good or bad thing will depend on the trader’s strategy for exploiting the volatility relationship.

But highly volatile market conditions would cause a lot of false signals and plenty of losses.

How do you interpret Swing Index values?

To interpret Swing Index values, you check where they are relative to the zero line. Values above the zero line are positive values, and they suggest an upward price swing. On the other hand, values below the zero line are negative values, and they indicate a downward price swing.

For trading signals, the values are better interpreted in line with the dominant trend. If the trend is up, then positive values may present buying opportunities. Likewise, in a downtrend, the focus should be on negative values.

What are common trading strategies using the Swing Index?

The common trading strategies using the Swing Index are trend-based swing trading and mean-reversion trades in a ranging market. If the market is trending, the strategy could be to look for swing index signals in that trend direction.

Thus, in an uptrend, the strategy would be to go long when the indicator crosses above the zero line, while in a downtrend, it would be to go short when the indicator crosses below the zero line. In a range-bound market, the swing index can also be used to make mean-reversal trades at the boundaries of the range — bearish signals at the upper boundary and bullish signals at the lower boundary.

How does the Swing Index handle market reversals?

How the Swing Index handles market reversals will depend on the type of market reversals. The indicator can show very short-term price reversals, such as the reversal of minor price swings. That is the basis of its signal — to identify and trade short-term price swings.

However, the indicator is of little use in identifying major or long-term market reversals, as it will keep flipping up and down.

Can the Swing Index be combined with other indicators?

Yes, the Swing Index can be combined with other indicators to get the best out of it. In fact, the indicator needs to be combined with other indicators or other forms of market analysis to reduce the chances of false signals.

Some of the best indicators that can complement the swing index include medium-term to long-term moving averages and the MACD. These indicators can be used to find the direction of the trend and price momentum and then use the swing index to find swing entries in that direction.

What are the limitations of the Swing Index?

The limitations of the Swing Index include:

• It is focused on very short-term price changes, and as such, cannot be used to identify the dominant trend.
• It is prone to price spikes and false signals.
• It is not suitable as a strategy on its own.
• It may have to be combined with other indicators to get the best out of it.

How do traders avoid false signals with the Swing Index?

To avoid false signals with the Swing Index, traders have to combine the indicator with other indicators, such as moving averages or the MACD. Alternatively, they can combine it with other technical analysis tools, such as trendlines and support/resistance levels.

Those tools will not only show the trend direction but also act as potential reversal levels. For example, let’s say the trendline shows that the market is in an uptrend. The likelihood of false signals is reduced if the only trades taken are the ones that pull back to the trendline and reverse while the swing index shows a bullish signal.

What is the difference between the Swing Index and Relative Strength Index?

The difference between the Swing Index and Relative Strength Index is that the former is a 2-bar momentum oscillator while the latter can be set to any period of choice. Both measure price momentum changes and can be used for swing trading.

However, while the RSI can be set at any period and used for different types of swing trading, the swing index can only be used for very short-term swing trades.

How does the Swing Index work with trend-following strategies?

With trend-following strategies, the swing index can be used to identify and trade impulse swings in the trend direction. As a momentum oscillator, the swing index can show when the pullback is reversing for a new impulse swing to emerge in the trend direction.

Thus, it can help traders create swing trading strategies that only take trades in the trend direction. Also, the indicator may be used as an exit strategy to spot a change in momentum in a winning trade.

What role does price momentum play in the Swing Index?

The role price momentum plays in the Swing Index is that it determines how the indicator moves, which is why the indicator is used as a measure of momentum. When the price momentum is to the upside, the indicator will rise above the zero line and stay up.

Conversely, when the momentum is down, the indicator will fall below the zero line and stay down.

How can the Swing Index improve trading risk management?

The Swing Index may not directly improve trading risk management, as it does not show you how much position size to carry per trade or where to keep your stop-loss order.

However, you can integrate it into your trading exit strategy. For instance, if you are in a long trade and the indicator turns bearish, it may be time to close your position.

What are the pros and cons of using the Swing Index?

The pros and cons of using the Swing Index are many. Here are some of the pros:

• The indicator shows the short-term price swings.
• It can be used for short-term swing trading.
• It can help in trade management.

These are some of the cons:

• It cannot show the direction of the main trend
• It is prone to many false signals
• It may not be useful as a standalone signal