Are you ready to try something new? If you’ve been trading stocks for a while, and you are looking to try something new, perhaps swing trading is for you. Because let’s face it, sometimes the buy and hold strategy can be less than exciting. It’s kind of like waiting for the paint to dry or the grass to grow.
Swing trading, on the other hand, can be a little more gratifying since you are looking to profit on short term moves in a stock. Swing trading is a broad term used to describe a number of short term trading strategies. These strategies can also be used to trade other investment vehicles like bonds, commodities, forex, and yes, even cryptocurrencies. For simplicity though, we will focus our discussion on stocks, although the principles are the same.
Swing Trading vs. Day Trading
If you’re a swing trader, your outlook will generally be longer than a day trader, but shorter than a long term investor. A swing trader will typically hold their position for more than a day, but no more than a few weeks. As a short term trader with this time frame, you can perhaps expect to get returns of between 5-20%. This is different from a long-term, buy and hold strategy where an investor will hold on to his position for months or even years, with the expectation of much higher gains.
The idea with a swing trade is to hold onto a stock to profit from short term price changes or swings. As the stock oscillates between optimism and pessimism, a swing trader will try to profit from those swings. Swing traders find opportunities by using technical indicators to identify patterns, trend direction, and potential short-term changes in trend. A swing trade will typically include three elements: the entry point, exit level, and a stop loss. The stop loss and exit level may not necessarily remain at a fixed price as they will depend on the technical trigger used in your strategy.
Picking the Right Stocks
Obviously, a good candidate for swing trades is one that trades actively and tends to swing between broadly defined highs and lows. Large-cap stocks would fit well into this category. Since you are not investing for the long term, the sector you are investing in and the stock’s fundamentals matter little. It is not necessary to look at a company’s debt levels or its price to earnings ratios. We are not interested in the company’s long term prospects. We are only concerned with where the stock will be in a couple of days or weeks, not years. So we rely primarily on technical analysis as opposed to fundamental analysis.
Looking at chart patterns is one of the most common forms of technical analysis used by traders. When a chart is showing an upward trend, most traders will go long and buy shares in the hopes of selling later at a higher price. When a stock is on the downtrend, most traders will short a stock. Shorting a stock means selling shares that have been loaned from a broker with the intent of buying them back at a lower price.
When there is neither a bullish or bearish trend, opportunities exist to swing trade as well. In such a case, the stock trades within a range. This presents an opportunity to take a long position near the support area and a short position near the resistance.
Pros of Swing Trading
- Swing traders take advantage of short-term price movements to maximize short-term profits. The market is continuously changing, and the swing trader can trade in and out, making profits all along the way.
- It is relatively easy to find stocks worth investing in.
- Swing trading is versatile and flexible. Swing trading strategies work with all markets including stocks, commodities, forex currencies, and more. These strategies can apply to ETFs, single stocks, and even cryptocurrencies.
- Availability of tools. There are many tools, platforms, and apps available that can help you.
- Swing trading offers a great risk to reward trading opportunities. You risk a smaller amount of your capital for a potentially much bigger profit compared to your risk.
- Swing trading eliminates a lot of intraday noise, compared to day trading.
- Using technical indicators reduces the risk of speculative trading and helps you to make clear decisions.
- Unlike day trading, you’re not constantly glued to the screen.
- Swing trading is suitable for those with a full-time job.
- Swing trading is less stressful than day trading.
Cons of Swing Trading
- Needs constant monitoring of market conditions and analysis to be profitable.
- It can be very risky because it is more susceptible to market volatility. There is a higher risk of losses beyond your initial investment.
- You may miss out on long term opportunities since the focus is only on the short term.
- You must be exceptionally good at technical analysis and master the art of interpreting charts, graphs, and technical analysis tools.
- Because swing trades play out over several days or weeks, you are exposed to the risks of “gaps” in trading overnight or over the weekend
- You are open to the risk of sudden reversals which can catch you off guard because you are not watching the screen all day. To decrease this risk, it would be wise to use stop orders with every position. Stop orders will lock in gains and limit losses.
Finding a Suitable Candidate
When searching for a suitable candidate for a swing trade, here’s what we can look for:
- Catalyst: We can begin by looking for a catalyst that will result in a powerful move in the stock. A catalyst might be an earnings miss or beat, some significant news such as a pharmaceutical company beginning a clinical trial, etc.
- Volume: Big moves in a short time frame are usually accompanied by large volumes. So try to find stocks that are trading with more volume than usual.
- Volatility: With great volume comes great volatility which is exactly what you are looking for if you are a swing trader. A stock trading within a tight range won’t produce as many opportunities as one with bigger moves.
Three Simple Swing Trading Strategies
What are some strategies? According to one source, these are some short term trading strategies that work:
Stuck in a box. In this scenario, a stock is stuck trading within a certain range. The idea with this one is to capture just one swing in the cycle. To do this, you would need to pick out the key support and resistance levels. If the price breaks below the support level, wait for a strong price rejection (i.e. close above support) to enter your trade. Go long and set your stop loss at some buffer (eg. 1 ATR) below the support level, and take profits before the resistance level. You will have the highest probability of success if you exit before resistance is encountered and selling pressure steps in.
Catch the wave. The idea with this strategy is just to capture “one move” in a market that is in an uptrend. If a market is in a healthy uptrend, the price will tend to bounce off the 50 day MA. In this strategy, we will be looking to capture one swing that is in line with the uptrend. The ideal time to enter the trade would be after a pullback has ended in order to capture the next uptrend.
How To Execute the Catch the Wave Strategy
1. identify a stock that respects the 50 day MA.
2. Wait for the price to come to an area of value which would be the 50 MA price before entering your trade.
3. Set your stop loss at some buffer (1 ATR) below the low and take profits just before the next swing high.
Fade the Move. For all you contrarian traders out there, this might be the strategy for you. This strategy is more aggressive because it is a countertrend move which means that you are trading against momentum. But if executed correctly, it will still offer a favorable risk to reward ratio.
When the market has been trending higher and has traveled quite a distance towards the swing high (towards resistance), there may be an opportunity to take a counter-trend trade. This means that you would trade on the next downswing. This trade requires care because the market can quickly turn against you.
Steps to Execute Fade the Move
1. Identify a strong momentum move into resistance that takes out the previous high. 2. Look for strong price rejection at the resistance level.
3. Go short on the next candle and set your stop loss at some buffer above the highs.
4. Take profits before the nearest swing low. Remember not to stay too long in the trade as you are trading against the prevailing trend.
Manage Your Trades
As with all trades, it is necessary to manage the risk in order to limit your losses and capture your profits. We can never fully predict how the market will trade. Therefore, we need to have some idea of what we will do if the trade we have entered into doesn’t hit our stop loss or reach our target profit.
There are two ways to manage our trades. We can do it passively or actively. In passive trade management, we allow the market to either hit our stop loss or our target profit. If it does neither, then we do nothing but wait. There are pros and cons to this method. The pro is that decision making is automated for us. The cons, however, are that you miss exiting your trade even though the market is about to reverse. And you risk having your profitable trade become a loss.