While the majority of stock market participants are investors who buy shares of stock and hold them for long periods of time as they grow, there’s a large population of active traders who are in it for the short-term moves.
After all, the battle between the bears and the bulls leads to constant ebbs and flows of market prices, creating opportunities with shorter time horizons.
One of the most common ways to take advantage of these swings in value is known as swing trading.
What Is Swing Trading?
Swing trading is a short-term speculative trading strategy that’s designed to give traders the ability to predict market movements. Swing traders look for opportunities that last for a period of time generally ranging from a few days to a few weeks, but the actual time frame from one trade to the next can vary wildly.
Swing trading strategies involve the use of various technical indicators and the measurement of price action over time. These indicators are used to determine entry points and outline the potential risk-versus-reward profile of each trade.
Essentially, swing traders use detailed analysis and charting capabilities to exploit stock market volatility for a profit.
It’s important to note that all trading and investing involves attempting to predict the future. These predictions prove to be less accurate when shorter periods of time are allotted for them to come to fruition, making short-term trading riskier. No matter how strong your strategy and analysis capabilities are, you’ll never have a 100% success rate.
As a result, it’s important to take steps to gauge and minimize risk with every trade. After all, when your risks of loss are low and potential rewards are high, you don’t have to be right every single trade to generate significant profits.
Pro tip: If you’ve been thinking about swing trading, we highly recommend looking into the Mindful Trader. With years of analytical analysis, he’s developed a strategy that has a history of profitability. He’s back-tested the results over the past 20 years and found that the median annual would have been 181%.
How Swing Traders Minimize Risk
When trading stocks, whether using swing strategies or otherwise, it’s important to have a solid trading plan. This plan will ultimately minimize the risk you’ll accept as you trade. An effective trading risk management plan includes:
1. The Use of a Stop-Loss
A stop-loss is a form of market order that creates an action when a predetermined price is reached. For example, if you purchase a stock at $50 and place a stop-loss order at $47.50, the shares will be sold automatically if the price of the stock were to fall to $47.50 or below, limiting your losses in the event of a sharp pullback.
These market orders are important regardless of what type of trading you do. After all, even the experts don’t place winning trades every time they make a move. It’s important to minimize the risk of downward price movements so you don’t get blown out when the market doesn’t go your way.
2. Analyzing Risk vs. Reward
When analyzing trading opportunities, the swing trader pays close attention to the risk-versus-reward profile of the trade. With risk being minimized by a stop-loss order, you know exactly how much money you stand to lose if things go wrong.
From there, you can analyze previous movements in the price of the asset to determine how high the price may go, setting a profit target designed to take a large chunk of the available profitability without pushing the limits too close to resistance.
If you are correct, the uptrend will drive the price to the profit target, leading to the trade ending and to you taking profits. This predetermined profit level is compared to the potential losses.
For example, if you stand to lose $1 if things go wrong or make $1 if things go right, the trade isn’t worth the risk. On the other hand, if you stand to lose $1 on a bad trade or make $3 on a good trade, the trade is worth the risk.
3. Doing Detailed Technical Analysis
Although no indicator or analysis tool is 100% correct at predicting the market, historically traders have used technical analysis to determine future price movements to assess patterns in the price of an asset.
The most profitable swing traders are experts at analyzing patterns in charts and comparing those patterns to historic trends to get an idea of what’s going to happen in the future. If you’re interested in swing trading, it’s important to hone your technical skills.
4. Taking Profit or Losses at Precise Times
Profitable swing traders are interested in taking a chunk of the profits available on price swings, but they aren’t willing to risk their earnings by pushing their luck to the limit.
Expert swing traders put emotion to the side and follow their strategy to the letter, resisting the temptation to follow an asset to or through resistance. Instead, they take profits before resistance fears have the potential to decimate them.
Technical Indicators and Tools Swing Traders Use
- Stock Screeners. Finding a great trading opportunity is just as important as following your strategy when taking advantage of it. There are several free screeners online that make it easy to find the types of opportunities you’re looking for. You can use a screener to instantly produce a list of assets that meet your criteria or display certain characteristics that make them candidates for a swing trade.
- Candlestick Charts. Candlestick charts are used because they show four points of data for each candlestick, including the open, high, low, and close price for the candlestick period. This data is invaluable for the swing trader when determining historic and likely future price movements.
- Moving Average Crossovers. Moving average crossovers relate to the action of a short-term moving average crossing above or below a long-term average. These crossovers are often used to determine entrance and exit points.
- Stochastic Oscillator. The stochastic oscillator helps traders determine if an asset is overbought or oversold while acting as a gauge of momentum. When the indicator reads under 20, it suggests the asset is in oversold territory, whereas a reading over 80 suggests the asset is overbought.
- On-Balance Volume. On-balance volume, or OBV, uses trading volume changes to predict future price movements. When OBV increases, it suggests that demand for the asset is increasing, and upward movement is likely ahead. When the OBV decreases, it suggests demand is waning, and declines are likely ahead.
There is a wide range of other technical indicators, each with the potential to provide important data and help you make more educated trading decisions. The more you learn about these indicators, the better chances you have of becoming a successful swing trader.
Mixing Fundamental Analysis Into the Process
While many traders who follow swing strategies specifically focus on the use of technical data, some mix in fundamental analysis in an attempt to get an even better understanding of the expected direction of the stock and how long movement will likely last.
For example, a swing trader may use one or more of the indicators above to find an opportunity. However, before acting on the opportunity, they might dive into the company’s fundamental data to make sure that the underlying company is growing, reinforcing their belief that the bullish signals are correctly predicting upward movement ahead.
Swing Trading vs. Day Trading
Swing traders and day traders have quite a bit in common. The two trading techniques both involve using technical data to analyze historic price trends in an attempt to determine what the price of an asset is going to do in the near term.
However, the two trading techniques have a key differentiating factor.
Swing trading techniques involve buying and holding assets at least overnight. In most cases, the time frame of the trade ranges from a few days to a few weeks. Day traders, on the other hand, work to exploit intraday price movements, always selling the asset by the close of the trading day.
Essentially, a day trade, as its name suggests, is a trade that takes place within a single day. Day trading is that much riskier because this short time window offers even less time for the predictions of price movements to come to fruition.
Example of a Swing Trade
Let’s say a trader has spotted ABC stock, which seems to be reaching support. The trader realizes that the stochastic oscillator reading is a low 17, the short-term moving average just crossed above the long-term average, and the OBV is rising.
All these signs are pointing to gains ahead.
The trader buys ABC at $10 per share, setting a stop-loss at $9.50 per share. Based on technical data, resistance seems to be somewhere around $12.50 per share. So, the trader decides they will take profits at $12 to avoid any chance of getting close to resistance and the price of ABC falling.
This trade will ultimately end in one of two ways:
- Profits. If the trader is correct, the price of the stock will rise to $12 per share, offering up $2 per share, or 20% in profits.
- Losses. If the trader is incorrect, the price of the stock will fall to $9.50 per share before it’s sold for a loss. In this case, the trader stands to lose $0.50 per share, or 5%.
Notice the imbalance between the potential upside and potential downside of this trade. If this trader were to place many trades that had a similar risk-versus-reward profile, they would stand to come out ahead even if they get half of their trades wrong.
Swing Trading Pros and Cons
As with any other trading strategy, there are benefits and drawbacks to following a swing strategy.
Pros of Swing Trading
There are plenty of reasons to be excited about following a swing strategy in your trading activities. Not only is this fast-paced trading strategy exciting, traders enjoy the following additional benefits:
- Can Be Applied to Various Assets. Stocks aren’t the only asset you can use this trading style for. In fact, it’s a popular style among forex and commodities traders as well as those who trade exchange-traded funds (ETFs).
- Potential to Beat the Market. When you trade, your ultimate goal is to make faster profits than you would make in a long-term investing model. There are plenty of swing traders who have a strong history of producing gains that beat market averages, meaning that when done properly, the technique can prove to be incredibly profitable.
- No Room for Emotion. Many trading strategies have liquid or unclear entrance and exit points, leaving room for emotional trading that will devastate your returns. When following a properly designed swing trading plan, you’ll know exactly when to buy and when to sell, leaving no room for emotions to take control over your trading process.
Cons of Swing Trading
While there are plenty of reasons to be excited about profiting from swings in the value of market assets, there are also significant risks and drawbacks that should be taken into account before you get started. These include:
- Holding Overnight. Day traders don’t hold assets overnight because this opens them to the risk of a gap down, which is when the price of an asset falls significantly while the market is closed, opening the next trading day with heavy losses. In this case, a swing traders’ stop-loss order won’t kick in until the market opens, resulting in larger losses than expected.
- Time Consuming. Any form of trading that requires detailed analysis of technical data is going to be time-consuming. Those who make the most money using this trading technique view trading as their full-time job. If you don’t have at least three or four hours per day to commit to your trading activities, a swing strategy may not be best.
- Missed Opportunities. Because those who take advantage of swing trading focus on the exploitation of near-term trends, they may miss longer-term opportunities to generate significant returns.
Practice Before You Risk Your Money
As with any other form of trading, swing trading is speculative and comes with increased risk compared to long-term investing. Considering this, it’s important to practice your strategy before you risk your hard-earned dollars on your first trade.
There are plenty of free trading simulators offered online, most of which are demo accounts offered by mainstream online brokerages. Through these simulators, you’ll be able to test your trading strategy in a real-world setting that mirrors what’s happening in the market in real time.
The only difference is that the money you’ll use to invest is virtual. As a result, if you lose money in a trading simulation, you’re not actually losing a penny of real money.
By testing your strategies in these virtual environments before risking your hard-earned money, you can protect yourself from making beginner’s mistakes that could cost you a chunk of your investing capital or scare you out of moving forward.
The fast-paced and often highly profitable world of swing trading is an exciting way to participate in the stock market. However, this same fast-paced, exciting activity can also result in painful losses.
If you decide to move forward as a swing trader, make sure to do your research and get a detailed understanding of how to read and analyze technical data. Your ability to use technical data to your advantage will directly relate to your ability to profit as you trade.