Introduction to Failure Swing Pattern

How To Trade With Failure Swing

When you’re planning to enter the world of stock trading, knowledge is the key to survive. Learning how to earn a profit makes the first chapter of the stock trading course, but understanding and reacting to market indications ahead of others lay the foundation. The failure swing is a critical trend reversal indication. In this article, we will discuss why failure swing pattern is so important in technical analysis and why it is among the most reliable trend reversal identifiers.

Trading following the trend is a rule of thumb followed by the traders and when they do that they also keep a watch for any early trend reversal signals to avoid ending up at the wrong side of the trend. The failure swing is critical for building a trading strategy when you find a weakness in the trend. It signals when the current market trend is weakening, and a new trend is emerging.

Key Highlights

  • Failure swing is a trend reversal signal
  • It occurs on both uptrend and downtrend, indicating sell and buy respectively
  • It helps identifying weakness in the current trend and spot early reversal signals
  • It occurs when the relative strength index (RSI) oscillator fails to match the higher high in an uptrend and the lower lows in a downtrend
  • The point where the RSI line falls below the recent swing low is called the fail point. It triggers the sell signal
  • Similarly, when RSI stays above the lowest low point of the current trend, it indicated buying signal
  • Failure swing is considered a strong enough signal for a reversal to act on it alone

What Is Failure Swing?

  1. Welles Wilder, Jr. introduced the concept in his seminal book, ‘New Concepts in Technical Trading Systems’, where he noted about failure swing.  It reads, “Failure Swings above 70 or below 30 are very strong indications of a market reversal.”

Let’s discuss it further in detail.

Relative strength index (RSI) is a momentum oscillator that is used in almost all trading software, quantifies changes in price and its impetus.  Check out the RSI Index article to learn about the momentum oscillator in detail.

Failure swing is a moment of RSI divergence when the price line and RSI line diverge from each other. It indicates a decline in the current momentum, especially when the market is in the overbought or oversold territory.

In a bullish phase, the market reaches the highest level or the overbought limit to slip down, it then picks up again but fails to reach above the previous high to fall back for the second time creating an ‘M’ shape in the trendline. This is where the failure swing occurs. Failure to reach a higher high in the uptrend is an indication that the current uptrend is weakening. Similarly, the opposite scenario happens in a bearish market. Once the market reaches the lowest low in the overselling territory, the second peak fails to reach that level and rises. In a bearish trend, it indicates the end of the selling spree and prompts traders to take a long position in the market.

Types Of Failure Swing

Failure swing top

The trigger line is drawn through where the first peak reaches the lowest point. If after the second peak of the failure swing, the price continues to fall below the trigger line, we can confirm a failure swing.

Non-failure swing

Here the price after reaching its peak rose again to create a higher level at point C. After that, the line falls below the first trigger line and end up in point D. this is where the second trigger line is drawn. The failure swing trend confirms when the price line violates the second trigger line and dips further. As a trader, you can wait for the failure swing trend to confirm before changing your position.

Similarly, we have two situations in the bearish market also. They are called,

  • Failure swing bottom
  • Non-failure swing bottom

Trading Using Failure Swing

Failure swing is used by traders to plan entry or exit. When failure swing occurs in the uptrend, traders take a short position, and during the downtrend, they would plan an entry.

Traders plan entry with the formation of the second peak before the failure swing occurs in the downtrend.

Failure swing pattern gives early signals of a trend reversal. Being able to spot it at the early stage will give you a head start to plan a trade-off and have a positive effect on your portfolio.