What is Swing Trading and How Does it Work?

Swing trading refers to buying and holding a stock or financial instrument for days or weeks before selling it for gains. In this case, traders often rely on technical analysis or fundamental analysis to spot good buying or selling opportunities. For technical analysis, indicators, chart patterns, and price action are often used. Whereas an asset’s market capitalization, use cases, demand, etc. can be used in fundamental analysis.

Consequently, swing traders greatly rely on an asset’s fundamentals since it is a great determinant of significant price movements. It will take days and even weeks for changes in fundamentals to trigger such movements, thereby yielding more profit. Fundamental analysis also helps to improve trade analysis. Here, a trader can verify if an asset’s fundamentals are favorable or could potentially improve in the near-term instead of relying only on bullish patterns.

Day Trading and Swing Trading

There are unique differences between day trading and swing trading. The most obvious difference lies in the fact that day traders open and closes their trade(s) on the same day. In contrast, a swing trader holds their trade for at least a night. As a consequence, this trade lasts well over a day and could run into weeks.

What’s more, the potential for an overnight risk to occur with swing trading often causes traders to take smaller position sizes. The unpredictability of the market could cause even the most well-analyzed trade to run into losses. On the other hand, day traders often take larger positions since they’ll be dashing in and out of the market, and as such, are not susceptible to overnight risk.

Furthermore, day traders may rely on a 25% day trading margin, unlike swing traders that may opt for a margin of 50%. For this reason, a swing trader that has been approved to carry out margin trading could place around $25,000 as capital for the trade. Whereas, the actual value of the trade may be around $50,000.

Differences Between Day Trading and Swing Trading

Other differences between day trading and swing trading include:

Trading Times

A day trader may have to spend an average of two to four hours daily analyzing charts, entering positions, getting out of positions, and reviewing trades. Alternatively, a swing trader who uses a daily chart to spot positions only needs around 45 minutes to find new trades and update their orders. Also, a trader who has chosen to hold their position for weeks may not even need to visit their trades every so often. That being said, day trading is more time demanding than swing trading.

Returns

Day trading yields faster returns since a trader can make smaller gains more quickly. These gains can be accumulated and at the end of the day, could result in huge gains. On the other hand, a swing trader may have to wait longer to take their profit. Hence, gains are accumulated slowly and the same can be said about losses. What’s more, the gains or losses may not be as much compared to a day trader.

Risks

Day trading means entering and exiting positions more often in the market. A day trader may carry out six trades per day while a swing trader might carry out six trades per month. However, the risk level is higher for day trading since the trader is more engaged in the market. They may experience more losses compared to a swing trader.

Pressure and Focus

A day trader is more exposed to market movements and may feel overly stressed and pressured. Likewise, a great deal of knowledge, focus, and discipline is needed to ensure that they do not blow their trading account. Either of these qualities is also needed to generate profit consistently. On the other hand, swing trading also demands high-level knowledge and discipline but the same cannot be said about focus. Therefore, traders that can’t maintain sustained focus are better off swing trading.

Capital Requirement

The capital required to become a day trader or swing trader depends on the market that is being traded. For instance, at least $25,000 in an account is needed to day trade stocks in the U.S. There is no legal minimum amount for swing trading stocks even though traders will need to hold at least $10,000 in their account.

Pros of Swing Trading

Some advantages of swing trading include:

Less Time

Given that swing trading involves holding an asset for at least over a day, it means this form of trading takes less time compared to day trading. Traders can, therefore, have enough free time on their hands to engage in other tasks instead of staying glued to their phones or computers day-in-day-out.

Increased Profit

In swing trading, trades are held for days or weeks which means more market swings are captured. That being the case, this trading strategy could result in more short-term profit for the trader since large price moments are captured in a single trade.

Heavy Reliance on Technical Analysis

Swing trading focuses on the current price action of an asset even though trades may be held for weeks. Needless to say, only technical analysis can be used to determine the next price movement, and this helps to simplify the trading process.

Cons of Swing Trading

Some disadvantages of swing trading include:

Overnight Market Risk

Unlike a day trader that enters and leaves the market the same day, a swing trader leaves their trade overnight. As such, their funds can be susceptible to overnight market risk. On the same note, if there is an unexpected reversal in price, it could lead to losses and even bigger ones if there was no stop loss.

Missed Profits

Just like a day trader would miss out on more profit by not leaving their trades for a long time, the same can be said about a swing trader. They’ll profit from short-term price movements, rather than long-term, which can be considerably higher and less time-consuming.

Tactics

Swing traders can rely on multi-day chart patterns to discover the right time to buy or sell. Some of these patterns include cup and handle, bearish and bullish flags, ascending and descending triangles, moving averages, etc. In the same vein, indicators such as dojis can be used to spot major reversals even before they occur.

Over and above that, a trader needs to use a strategy that helps them to win many trades. Here, they can keep a close eye on trade setups that often actualize predictable price movements. There’s also the risk/reward to be considered to ascertain if a trade is worth it in the first place.

A trader’s success rate at swing trading can be measured using the width of the trading channel. For instance, if a stock was bought at the bottom of the line and sold when the price hit the top of the channel line, it can be said that the trade was a 100% success. However, if the stock was sold when its price made it halfway to the top of the channel line, then the trade was a 50% success.

Important Things to Keep in Mind

There are important things to keep in mind if you must be a successful swing trader. They include:

Right Stocks

To swing trade successfully, you need to select the right stocks to make the most profit. Here, you can opt for stocks with large market capitalization. An asset with a large-cap shows that it is among the most actively traded ones on top exchanges. The high capitalization also means the asset’s price may tend to fluctuate significantly in active markets. As a consequence, you’ll be able to trade in one direction for days or weeks, and when the trend reverses, you can also trade in the direction of the new trend.

Right Market

There’s the bear market on one hand, and the bull market on the other. Likewise, there is a stable market between either of these, however, swing trading in a bear or bull market is quite different from that of a stable one. For instance, stocks may tend to spike and dump using different patterns in either of these markets, unlike a stable market where the same pattern could be maintained for weeks or months.

Also, in a bear or bull market, the momentum may cause stocks to trade in a particular direction for a long time. As such, to reap the most profit, you’ll have to trade in the direction of the long term trend. And for that to happen, a swing trader has to correctly determine the current market, whether it is bearish or bullish.

What’s more, the trader is well-positioned when the market is heading nowhere. Here, the stocks or indexes may rise for some days, then fall after some days, and then repeat the same pattern over and over again. Accordingly, the swing trader would’ve had numerous opportunities to capture the highs and lows of the same pattern.

Exponential Moving Average

The simple moving average (SMA) offers precise support and resistance levels. It also shows bullish and bearish patterns. When the stock hits the support level, it signals a good time to buy and when it hits the resistance level, it is a good time to sell. The bullish and bearish patterns also signal entry and exit price points.

Another form of SMA is the exponential moving average (EMA), and it focuses on the latest data points. The trend signals, as well as, entry or exit points offered by the EMA is faster compared to the SMA. The 9, 13, and 50 periods EMA can be used to better time entry points.

For instance, when the price of a stock crosses these EMAs, it indicates a bullish trend. Hence, there could possibly be a reversal from the bearish trend. An example is when the 9 EMA crosses the 13 EMA while the 13 EMA is above the 50-period EMA, it signals a buying opportunity.

The same logic is applicable when trying to spot a reversal to a bearish trend. In this case, the price of a stock will be below these EMAs. The 9 EMA will be below the 13 EMA, and the 13-period EMA will be below the 50-period EMA. Generally, the 50-period EMA will be above both EMAs.

Taking Profits

It is important for a trader to time their exit points so as not to suffer losses due to a reversal to the downside. Therefore, the trade can be exited when the stock’s price is close to the upper channel line. However, this is applicable in a weak market when the momentum is low since it is possible for the price to reverse even before reaching the channel line. In a market with high momentum, profits can be taken after the price has hit the channel line.

Swing Trading Examples

Here are some examples of swing trading:

Example 1

Imagine a chart where the market is in an uptrend and a cup & handle pattern is formed. This pattern indicates that the price movement will continue in the upward direction if the stock’s price surges past the handle of the cup. That being the case, a swing trader can long at the first breakout above the handle.

However, it is important to place a stop loss below the cup’s handle to ensure that if there’s a major reversal, you do not lose a greater part of your capital. So let’s say you bought a stock around $52.70, your stop loss can be placed around $47.60. For the setup above, the loss would’ve been $5.10 per share.

It is also important not to place the stop loss too close to the price you bought at in case there is a fake dip and the price reverses to the top again. Needless to say, you need to calculate the percentage you can afford to lose and set your stop loss around that level. Asides from the price retracing below its handle signaling an exit, if the stock makes a new low after it surges, it could also signal an exit point.

On the other hand, you can also determine how much you can profit to see if it exceeds this loss. The aim is to determine the risk/reward if the reward is significantly higher than the profit. For instance, if you actually purchased at $52.70 and sold at $60.46, it would’ve marked a 37% profit. Whereas, the $5.10 loss would’ve marked a 9% loss. Therefore, this trade would’ve been worth it since the profit is significantly higher than the loss.

Example 2

Find a stock that has been trading towards the upside for the past week, and has made short & sharp bottoms on its daily chart. Also, ascertain the stock’s behavior since the uptrend began and note if its price returned to the moving average thrice. If it did, and also penetrated the moving average at an average of 1.5% of its price, a buy order can be placed. This order can be approximately 1% of the stock’s price below the moving average.

Once the trade has been entered, it is advisable to place a stop loss close to the entry point to curb losses. And profits can be taken close to the upper channel line for weak markets, and at the upper channel line, for strong markets. The point is taking profits according to your trading plan, but a professional trader may opt to hold for a while longer till when the market does not visit new highs.

The Bottom Line

Swing trading is an active trading strategy that can be adopted by anyone who wants to make a profit while in the market, and also invest their time in other activities. The same applies to an individual who seeks to reduce their level of risk since they’ll be capturing fewer moves in the market compared to day trading. At the end of the day, whether it’s swing trading or day trading you opt for, it is important to implement risk management to ensure you do not end up with fewer funds than you began with.