Swing theory and swing charts in technical analysis are theory around charts that belongs to the technical analysis family of “reversal charts”. The most frequently used type of swing chart is the Point and Figure (P&F) chart, which is said to have been invented in the late nineteenth century by the legendary trader James Keene. Other members of the same swing theory in technical analysis are renko, kagi, and three-line break charts – some of which I have covered in other articles.
We can define a reversal chart as any chart that filters the raw price data to highlight only the important price points. It is common knowledge in the technical analysis community that valleys and peaks are of most interest whereas sideways movements in the market don’t provide much information, and therefore are not as interesting.
Bottoms and peaks are those points of the price action where the direction reverses and the slope of the existing trend changes its arithmetic sign. Below I will use the original terminology from Ralph Elliott to avoid potential confusion with other technical analysts.
A wave is a single straight diagonal line on a chart. Waves always have slope, i.e. they are never parallel to any of the axis in the chart.
A peak is a point of intersection between an upwards sloping wave on the left and a downwards sloping wave on the right, i.e. this is a local maximum for the price.
A valley is the point of intersection between a downwards sloping wave on the left and an upwards sloping wave on the right, i.e. this is a local minimum for the price.
A cycle is just a series of interconnecting waves which will invariable have peaks and valleys in between.
In order to draw and Point and Figure chart we then need determine one key additional input: the box size.
The most frequently used box size in swing theory is the minimum price amount in which the currency can change. In Forex markets this is a pip. There are three cases where the box size can be greater than one pip.
First, this is when the parity rate between the two currencies causes a large bid-offer spread. For example for the EURCZK pair the bid-ask can be 350 koruny, meaning one pip has no filtering meaning.
Second, in swing charts a larger box size can be used when analyzing historical data on a longer timeframe. In this case, the trader would be looking for major price movements rather than intra-day trend reversals.
Lastly, swing chartists can choose to use a larger box size to align peaks and valleys on a chart but this is a personal preference.
There are a number of other inputs that need to be set when applying swing theory such as the reversal amount. There is are a number of free websites offering great information on swing charts and I strongly encourage you to have a look at them. They can make the difference between you achieving wealth trading Forex or not.