What Is Swing Trading: Meaning, Strategies, Examples

There are many trading techniques helping investors take advantage of different financial markets. All of them vary according to the execution pace (short-term or long-term), devoted time (passive or active trading), position size, level of risk, required skills, amount of necessary expenses, and many other factors.

Swing trading is one of the most popular approaches among both beginners and experienced traders. This article will provide you with a complete overview of this trading style, its main features, definitions, common strategies, merits and drawbacks. Continue reading and find out if it’s worth trying on your investment portfolio.

What Is Swing Trading?

Swing trading is a short- to intermediate-term trading strategy. It implies that traders focus on short market movements (known as swings) that usually last from a couple of days to several weeks. Although potential gains are smaller due to a shorter trading period, if achieved continuously they could accrue into a significant amount, the same applies for potential losses. When it comes to instruments, helping traders realize market opportunities, swing trading could involve the use of both technical and fundamental analysis.

How Does Swing Trading Work?

Swing trade strategy is based on the principle that the market doesn’t strictly follow the trend line, it fluctuates. Thus, swing traders are trying to take advantage of these minor market swings within the major trend. To do so, they have to define the swing highest and lowest price level. Then, in case the market shows an uptrend, they go long and speculate from the lowest to the highest price level. If the market is in the downtrend, they go short, speculating in the opposite direction. The main goal is to try to capture as many of these swings as possible. Another key element that has to be defined is stop-loss orders. They help investors mitigate the risks, preventing losses from growing larger.

Swing trading can be about highly volatile assets, fluctuating to a great extent, or more stable ones. The choice is up to the trader and his willingness to be either more active or passive. In any case, the idea is to correctly identify the swing, open the trade, and profit if the expectations are fulfilled.

The Role of Technical Analysis

To develop a robust and efficient swing trading strategy, many traders turn to technical analysis. They explore the past asset performance and use it as a base for their future actions. Technical analysis consists of two main components:

• Chart patterns involve the analysis of trading charts to define the levels of support and resistance.
• Technical indicators are various forms of calculations, algorithms, etc., helping investors to successfully identify swings. The most common indicators include moving averages (MA), relative strength index (RSI), and others.

Example of Swing Trading

Let’s say that an investor wants to trade stocks of a fictional company “XXX” using a swing strategy. Firstly, he has to decide what tactic and indicators to use. In this example, we will consider a swing trade based on the Moving Average Convergence/Divergence (MACD) technical indicator. Note that, MACD allows investors not only to identify the trend but also buy and sell orders.

• If the MACD line goes above the zero line, it’s a signal for an uptrend. If it crosses it below the zero line, this implies the downtrend.
• If the MACD line crosses the signal line from down to up, it is a buy (bullish) signal. If it crosses it from up to down, this is a sell (bearish) indicator.

In our case, the trader was exploring the charts of XXX company stock and noticed that the MACD indicator sharply crossed the signal line from down to up. He opens a long (buying) position of 100 stocks. Following the expectations, the XXX stock price is growing. After holding this position for a week, the investor closes the trade, reaping a percentage of profit. In case the trader’s observations were wrong and the stock price is decreasing, the investor could have protected his capital by placing a stop loss order.

It’s necessary to remember that in swing trade strategy speculators are not interested in long-term price prospects, they only pay attention to short-term movements in the asset value.

Advantages and Disadvantages of Swing Trading

Like any other strategy, swing trading comes with its merits and drawbacks. Let’s have a closer look at the most important of them.

Pros:

1. Time commitment. Swing trading is a time-efficient approach that of course, requires more actions in contrast to long-term techniques, but is much calmer than day trading. A swing trader doesn’t need to spend all day in front of the screens, trying to analyze price charts, thus can combine trading with their main job.
2. High potential profits. The profit per single swing trade is smaller than in long-term strategies. However, if a trader implements this technique continuously and in compliance with a robust risk management plan, the total trading return may accrue to larger sums.
3. Flexibility. Swing traders can manage their funds easier. Due to the short timeframes, their capital is not locked in a single trading position for a long time. Thus, if something goes wrong, they can exit the trade with a minimum loss and reinvest their money in a new position.

Cons:

1. Risk. Since swing trading usually lasts more than a day, it’s exposed to more pitfalls, such as overnight and weekend gap risks. They may occur if significant market news gets released in the after-hour markets. As a result, when the market opens there can be a big gap between the asset price at the end of the day/week and the time the market opens again. Even the stop-loss orders wouldn’t be of much help in such situations. The only thing investor can do to mitigate gap risks is to opt for a smaller position size and avoid using the leverage.
2. Learning curve. Although swing trading is a good strategy for either newbies or professional traders, it still requires much knowledge and skills to become efficient. It can be challenging even for experienced investors to identify successful swings.
3. Psychological pressure. A swing trader should be self-disciplined and patient since it’s often complicated to resist the temptation to close the trade while facing some minor temporary losses.

Why Risk Management Is Critical In Swing Trading

Risk management is a core element of successful swing trading. It’s one of the main instruments, helping investors protect their funds and limit the risk of losing them all. The development of a risk management plan, as well as of a trading strategy, is very individual. However, there are some common rules to follow. Here are the most crucial of them.

• 1% rule. This common technique suggests that a speculator should not invest more than 1% of his funds or trading account into a single trade. For example, if a trader has $50000 in his account, he’d rather not put in more than $500 in one position.
• Stop-loss orders. It’s a specific level of buying or selling price set by an investor to limit his position from substantial losses. Thus, if the price drops below the stop-loss level (for long positions) or rises above it (for short positions), the trade will be automatically closed.
• Follow your well-designed plan. Although this tip may seem very simple, it’s extremely important. Not only is it crucial to develop robust risk management and trading strategies but also to stick to them despite possible psychological temptations.

Day Trading vs. Swing Trading

The main difference between day trading and swing trading is the time the position is held. As mentioned before, swing positions are usually kept more than a day, from two or three days to a couple of weeks. Day trading, as its name suggests, is about positions opened and closed within one trading day. As for the size of opened trades and their frequency, day traders usually open larger positions, and since they conduct numerous trades within one day their potential profits grow faster. When it comes to risks, swing trading unlike day trading is exposed to overnight risks and weekend gaps as swing trades stay open for a longer period.

Swing Trading Strategies

Swing traders can implement various techniques to identify trading opportunities and define when it’s reasonable to open or to close their positions. Here are some of them.

Breakout Trading

This strategy implies taking advantage of the market momentum and entering the trade as soon as possible. Traders following this technique try to detect the points when the market is likely to break out. Moreover, they have to find out how strong this momentum is and how long it is going to last.

Support And Resistance

The support line represents the level where the price stops falling and starts to recover. The resistance line shows the level where the asset price stops growing and starts to drop. To identify these lines traders have to analyze the history of asset price fluctuations, implement technical indicators (moving averages, trendlines, etc.), and other instruments. Not only can these lines help traders define the entrance and exit points but also efficiently set the stop-loss orders.

Fibonacci Retracement

Fibonacci retracement is another tool, helping investors define support and resistance lines. It is usually divided into certain levels: 23.6%, 38.2%, 61.8%, and 78.6%, which allow traders to identify possible price reversals.

MACD Crossover Point

MACD strategy is based on two key elements a MACD line and a signal line. The crossover of these lines can be a signal either of buying or selling. When the MACD line crosses above the signal line, it’s considered a buying signal. In contrast, when it crosses below the signal line, this is a selling signal.

As it was mentioned before in the swing trading example, the MACD line can be compared also with the zero line. If the MACD line rises over the zero line, the market is going to move up. If it goes below the zero line, it’s a signal of a downtrend.

What Are Some Indicators or Tools Used by Swing Traders?

The most common instruments and tools used by swing traders include but are not limited to:

• Moving averages (MA, MACD, FTSE moving average, etc.) aim at identifying market trends.
• Relative strength index (RSI) is a momentum indicator that allows investors to analyze if the market is oversold or overbought.
• Fibonacci retracement creates percentage levels between the highest and the lowest price points.
• Cup-and-handle pattern, where the “cup” serves to identify the bullish market movement while the handle is a signal of a slight downturn.

Which Types of Securities Are Best-Suited for Swing Trading?

The choice of the security for the swing trade depends on the level of risk investors are ready to accept. However, it’s reasonable to give preference to large-cap stocks which are characterized by high liquidity. Being always traded actively, they are likely to continuously fluctuate between the highest and the lowest price levels, providing swing investors with more trading opportunities.

How to Swing Trade

Once decided to swing trade, investors have to follow these simple steps.

1. Ensure you have a trading account. It’s necessary to find a trustworthy broker and open a trading account. Moreover, before getting started, it’s reasonable to get some experience with a demo account.
2. Use technical analysis to understand market conditions. Various technical indicators, patterns, and charts will help you identify the swing, entry or exit trade points, stop-loss levels, etc.
3. Opt for the asset. Swing strategy is used to trade a big variety of assets such as stocks, forex pairs, commodities, etc.
4. Define entrance and exit points. Relying on the conducted market research, set the timeframes of your trade and use risk management tools such as stop-losses to minimize potential losses.
5. Keep track of your position. Continuously monitor your position while it stays open.
6. Exit the position. If the trade wasn’t closed automatically by a stop-loss order, close it by yourself, following your trading strategy and risk management plan.

Conclusion

Swing trading strategy is a popular way to get involved in the financial markets. It helps investors stay in between active techniques and passive approaches, reaping the benefits of both. No doubt, that like any other strategy, swing trading has its drawbacks. As a short-term technique, it’s still quite stressful and time-consuming, as an intermediate-term one, it implies overnight and weekend risks. However, swing traders can minimize the losses and profit from high potential returns when implementing and following an efficient trading and risk management plan.