Swing Trading

• What is swing trading?
• Benefits
• Key strategies
• Steps to get started
• Tools and resources
• Common mistakes to avoid
• FAQs

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• Swing trading is a speculative strategy where investors buy and hold assets to profit from expected price moves.
• Swing traders leverage technical analysis to determine entry (buy) and exit (sell) points.
• Swing traders are exposed to gap risk, where a security's price changes while the market is closed.

Investors approach the stock market with a variety of goals. Many invest for the long-term, seeking to build wealth over time, while others trade for short-term profits — and many people do both. There are a variety of strategies for trading, but one of the most accessible to newcomers is swing trading.   

Unlike day trading, where trading is extremely fast-paced, swing trading is slower. This strategy is a great way to understand market movements and dip your toe into technical analysis. Here's what the curious trader should know.

What is swing trading?

Definition and overview

Swing trading is a trading strategy where investors buy a stock or some other asset and hold it — known as holding a position — for a short period of time (usually between a few days and up to several weeks) in the hopes of turning a profit.

The goal of the swing trader is to capture a portion of any potential price movement or "swing" in the market. Individual gains may be smaller as the trader focuses on short-term trends and seeks to cut losses quickly. However, small gains achieved consistently over time can add up to an attractive annual return.

How does swing trading work?

The swing trader analyzes patterns in trading activity to buy or sell a stock in order to capitalize on price movements and momentum trends of stocks, typically focusing on large-cap stocks since they are the most heavily traded. 

Because these stocks have high trading volumes, they offer investors insight into how the market perceives the company and its security price movements. This active trading offers the information necessary for what's called technical analysis, which we'll cover in the next section. 

As with any style of trading, swing trading carries plenty of risks. Swing traders are exposed to several types of risk, the most common being gap risk, where a security's price rises or falls significantly based on news or events that occur while the market is closed, whether overnight or during a weekend.

The opening price will reflect the shock of any unexpected news. The longer the market is closed, the greater the risk. Abrupt changes in the market's direction also pose a risk, and swing traders may miss out on longer-term trends by focusing on shorter holding periods.

How swing trading differs from day trading and long-term investing 

Swing trading and day trading are similar, while long-term investing is something else entirely. Swing trading involves entering positions and keeping them open for a matter of days or weeks. 

While the aforementioned approach might involve executing multiple trades per week, day trading might involve making several different trades in a single day. 

Long-term investing means entering positions and holding them for a sustained period of time, which could mean years or decades. A person accumulating wealth for retirement, for example, might enter a position they plan on holding for the next 30 years. 

Benefits of swing trading 

Flexibility

One of the major benefits of taking part in swing trading is flexibility, as using this approach does not require constant attention like day trading would. 

As a result, busy professionals can incorporate swing trading into their lives, entering positions and exiting them when the time is right instead of constantly placing trades while markets are open. This results in swing trading requiring a lower time commitment than day trading would. 

Potential for higher returns 

By using swing trading, you can potentially generate more compelling returns than you would by using a buy-and-hold strategy. More specifically, you can produce greater returns using this approach by making use of short-term trends in the global asset markets. 

You can use swing trading approaches to take profits when your positions rise in value, and then you can enter new positions to realize additional gains. 

Key strategies for swing trading 

Technical analysis 

Technical analysis involves studying a security's market history, specifically its price movements and changes in trading volume, in order to pinpoint trends and get a better sense of what that security will do going forward. By examining a stock's price history, for example, you can identify trends and use that information to determine the best time to enter a position. 

Fundamental analysis 

Fundamental analysis involves looking at the fundamentals of a security, for example revenue and earnings in the case of a stock, in an effort to determine that asset's fundamental value. Different investors have varying formulas they can use to calculate the fundamental value of a company's stock based on factors like that company's top and bottom line. 

Using this fundamental value, a trader can attempt to gauge whether a share of stock is undervalued or overvalued, information that can then be used to determine whether buying shares of that particular stock would represent a solid opportunity. 

Combining technical and fundamental analysis 

Traders can incorporate both fundamental analysis and technical analysis into their strategies. They can use fundamental analysis to identify stocks that they consider undervalued, and therefore compelling investments, and then they can use technical analysis to pinpoint the best time to open a position by buying some shares of that stock. 

Common swing trading indicators 

One of the most common indicators used in swing trading is moving averages, which help traders to get a better sense of a security's average price over a certain time frame. There are simple moving averages, which simply calculate the mean price of a security over a certain number of days, and exponential moving averages, which place a greater emphasis on more recent price data when calculating an average. 

Another go-to indicator is the relative strength index, which attempts to measure whether a security is oversold or overbought by evaluating its recent price movements. If a security is overbought, it may soon be heading for a trend reversal and lose value, but if oversold, it could be on its way to moving higher. 

Volume can be very helpful as an indicator, as it can shed some light on the strength of a price trend. If a stock rises in value, and this coincides with significant trading volume, this points to a robust, upward trend. 

Steps to get started with swing trading 

Choosing the right brokerage 

There are many different brokerages out there, so it is important to find one that is a good fit for you. The resources offered by these platforms can vary quite a bit, as some of them offer substantial educational resources you can use to learn the ropes. 

Others are a bit more barebones. Fortunately, there is a wealth of information online about any potential option, which you can use in order to make a well-informed choice. 

There are discount brokers and full-service brokers. While the former will execute trades for less money, the latter can provide some helpful guidance that may help you make more effective trades. 

Setting up your trading account 

Once you have chosen the best brokerage account for you, you need to set up a trading account, which requires you to fulfill several key requirements including verifying who you are. Documentation will be necessary here, so it is a good idea to prepare in advance by having the required materials. 

Developing a trading plan 

Before you start trading, it is crucial to develop a formalized plan. You may want to spend a few months testing out any proposed plan using paper trading, and once you know your strategy will turn a profit, then you can use it using actual capital instead of a practice account. 

Risk management techniques 

There are a handful of techniques you can use to help manage the risk associated with swing trading. For starters, avoid putting too much of your available capital into any one trade. 

Mike Dombrowski, head of capital markets at InterPrime Technologies, emphasizes the importance of risk management, saying that "each position should be roughly 2%-5% of total trading account capital. The most aggressive and professional traders may go up to 10% per position. That means a portfolio of five concentrated swing trades would represent 10%-25% of total trading account capital on average." 

"Having cash in reserve allows you to add to the best-performing trades to help generate larger winners. As always, the key to swing trading is to minimize losses."

It is also crucial to avoid overtrading, which is excessive trading. In other words, refrain from entering too many positions, an action that could easily cause you to lose your focus by causing you to open up so many trades that you can't easily keep track of all of them. 

People can easily fall into overtrading if they become emotional and let that guide their trading. Instead of falling into this trap, investors interested in swing trading can benefit from creating a plan and sticking to it. 

Another technique is choosing profit targets for individual trades that you are likely to achieve. If you want to purchase a blue-chip stock in the hopes that it will rally 100% in a matter of months, you may be disappointed. 

Stop-loss orders are a vital tool in managing risk. When a stock falls below the stop price (or rises above the stop price for a short position), the stop-loss order converts to a market order, which is executed at the market price. With stop losses in place, the trader knows exactly how much capital is at risk because the risk of each position is limited to the difference between the current price and the stop price. 

A stop loss is an effective way to manage risk per trade. 

Tools and resources for swing traders 

Charting software 

One resource that can prove helpful in your swing trading efforts is charting software, which can help you perform careful technical analysis so you can enter and exit positions at opportune times. 

News and analysis platforms 

There are a wide range of sources that can provide you with the news you need, and there are also many resources that can offer you analysis so you can make well-informed trades. 

While there are many websites that offer less-than-ideal news coverage, which could be biased or factually inaccurate, keep in mind that market data is more difficult to fabricate. 

Financial websites, for example, can offer very helpful information that you can use to enter trading positions in an informed manner. 

Common mistakes to avoid in swing trading 

There are some mistakes that swing traders commonly make, and being aware of these can be extremely helpful in achieving your business objectives. 

Overtrading 

Overtrading refers to excessive trading, an activity that can quickly become troublesome. One of the benefits of swing trading is that you can use this approach without opening too many positions, so overtrading would basically mean passing up this particular perk. 

Ignoring risk management 

Another way you could run into serious trouble is by neglecting to use prudent risk management. There are many different ways you could manage risk in swing trading, including techniques outlined earlier in this article, and refraining from following these simple steps could cause you to suffer notable losses. 

Letting emotions drive decisions 

One of the easiest ways to fail as a trader, whether that is as a swing trader or day trader, is to let your emotions seize control and dictate the positions you enter. To avoid this trap, develop a plan and stick to it. 

Swing trading FAQs

Swing trading involves entering positions and holding them for time frames of a few days to several weeks so you can capitalize on trends or "swings" in the markets. 

Swing trading and day trading differ since the former may involve entering several positions in a week, while the latter might entail entering multiple positions every week day. 

Technical analysis and fundamental analysis are both helpful strategies that can help an interested investor make the most out of swing trading. An investor can combine these two approaches to identify undervalued stocks and then enter them at an opportune time. 

You can get started with swing trading by setting up a brokerage account, funding it, developing a trading plan, entering some positions, and participating in prudent risk management. 

Essential tools for swing trading include charting software, news and analysis platforms, and sources that will provide the needed real-time market data. 

Reference

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