This guide will investigate what swing trading is. It will present the reader with various swing trading strategies, rules to abide by, when to buy and sell, how to limit losses, as well as the pros and cons of using this trading method.
What is swing trading?
Technical analysis is the ‘bread and butter’ of swing traders, who use it to identify patterns, examine investor sentiment, and spot potential short-term changes in trends. Nevertheless, swing traders should also be able to analyze an asset’s fundamentals to support their technical evaluation.
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How to find stocks for swing trading?
The key to successful swing trading is picking the right stocks, as poor market selection can significantly weaken your trading strategy. There are two essential factors to consider when selecting the stocks to swing trade:
- Liquidity: The best candidates for swing trading are large-cap stocks since they’re among the most actively traded on the market, i.e., they have the highest trading volumes. Highly liquid stocks make it easier for swing traders to exit positions quickly and with less risk of a loss from the bid-ask spread, as highly liquid assets generally show lower bid-ask spreads. Moreover, because technical analysis is a significant part of swing trading, choosing large-cap stocks that consistently demonstrate established chart patterns is preferable;
- Volatility: Volatile markets are the best for swing trading as this is where most trading opportunities emerge. However, while the stocks with the highest volatility present the most lucrative opportunities, they also come with the most risk. In addition, traders should limit leverage in volatile markets.
Swing trading in different markets
The market can move up, down, and sideways. Therefore, swing traders should apply an appropriate strategy to each market environment.
In a downmarket, we can expect prices to fall long-term, so it’s not recommended to buy an asset and hold it with the hope of price appreciation (aside from long-term investing strategies). Instead, there are several techniques to tackle this problem:
- Shorten your holding period: Instead of holding for weeks or months, be prepared to have a faster turnaround on your assets;
- Hold extra cash: Intend to withhold some of the funds you’d typically use for trading in case your holdings experience significant losses;
- Buying put options: Investors can profit in bear markets by short selling, which involves selling borrowed shares and repurchasing them at lower prices.
Contrary to a downmarket, trading in an upmarket is relatively straightforward. Since prices during these market conditions tend to rise, traders can buy a security and typically expect to sell it at a profit later. However, swing traders should consider the following factors when trading during bull markets:
- Prices are higher: Prices will likely appreciate in an upmarket, be prepared for higher costs when you open new positions;
- Don’t get too comfortable: Continue to research the assets you trade. While the market, in general, is trending upward, every security won’t be a winner;
- Consider incorporating leverage: Though margin trading is risky because you’re using borrowed money, if you are confident in the continual appreciation of the market, you may be able to amplify your gains through leverage. Beware that margin trading comes with additional account fees, interest charges, and the risk of liquidation of your positions in case you can’t meet the conditions of a margin call.
The best swing trading conditions are present in markets that are trading sideways. You might want to consider swing trading in these markets for two reasons:
- Volatile conditions are preferable: Volatile markets are ideal for swing trading as they present the most opportunities for profit. Additionally, when volatility is strictly in one direction, it is often more challenging to close positions at the right time;
- Low-risk conditions: Neutral market conditions tend to minimize losses because prices are likely to rebound.
Swing trading strategies
A swing trading strategy involves capitalizing on market swings by identifying lucrative entry and exit points for trades. This is done primarily with the help of technical analysis, which studies past trading activity (by examining trends and patterns seen on price charts) to gain insight into market sentiment.
Important: Before risking your capital, you should test your strategy on a demo account. A demo account is a simulated trading environment that allows you to practice trading techniques in real-time before funding your account and placing actual trades. However, simulated results rarely correlate to actual trading results.
Traders can deploy many techniques to look for actionable trading opportunities based on technical analysis, including using:
Swing traders use moving averages (MAs) to provide support and resistance levels and bullish or bearish crossover points. Traders can choose between the simple moving average (SMA) and the exponential moving average (EMA). The EMA might be preferable for some since it places more weight on the latest data points and can give traders more precise trend signals than a simple moving average.
Support and resistance levels
Support and resistance levels are vital for interpreting chart patterns, identifying trend direction, and entry and exit points.
Crossover patterns can forecast potential changes in a trend and signal both entry and exit points. For example, traders can utilize the 9-, 13-, and 50-day EMAs to look for crossover points. A bullish crossover occurs when the stock price moves above the moving averages, signaling an upward trend in price. In this case, traders may want to open long positions. Conversely, a bearish crossover occurs when the stock price drops below the EMAs, telling traders to exit long positions and potentially take short positions.
Golden and death cross pattern
Swing traders can use the golden (the shorter MA crosses above the longer MA) and death cross (opposite to the golden cross) patterns to signal trend reversals. For example, if a swing trader sees a golden cross forming, they might enter a long position in anticipation of prices rising. Similarly, if they notice a death cross forming, they might choose to exit a position in anticipation of a bear market.
Moving Average Convergence/Divergence (MACD) crossovers
The MACD, or moving average convergence divergence, is a popular swing trading indicator used to determine trend direction and reversals to help spot entry and exit points. The MACD consists of two moving averages, the MACD and the signal line, and buy or sell signals are generated when these lines cross.
When the MACD line crosses over the signal line to the upside, it is deemed a bullish signal (buy). Conversely, a fall below the signal line is a bearish signal (sell). Moreover, the MACD line turning up from below zero is considered a bullish signal, while a turn down from above zero is bearish.
Fibonacci retracement pattern
Swing traders may use a Fibonacci retracement indicator to identify potential reversals, support, and resistance levels, as well as place stop-loss orders and set target prices. The Fibonacci retracement ratios of 23.6%, 38.2%, and 61.8% are believed to reveal possible reversal levels.
This swing trading strategy requires identifying a stock displaying a strong trend and trading within a channel. A channel occurs when an asset’s price moves between two parallel trendlines, with the upper trendline connecting the swing highs and the lower trendline connecting the swing lows in price.
The price breaking out of a trading channel to the upside indicates a possible price rally, i.e., the trader should go long. On the other hand, a price break below the bottom of the channel suggests that more selling could be on the way, signaling an exit or a shorting opportunity.
Cup and handle pattern
The cup and handle is another favorite chart pattern swing traders use to find trading opportunities. This pattern is considered a bullish signal, indicating the continuation of an upward price movement.
For example, a profitable trade would likely put the entry point at the top of the cup, i.e., at or above the most recent high, and place a stop-loss at the most recent low in the cup handle.
Swing trading rules for beginners
Now that you have your strategy in place, first, remember that consistent results can only come from relentlessly practicing your technique under numerous market conditions, which involves making hundreds of trades in your demo account before risking any real money. Second, consider these three tips as non-negotiables before you move on:
- Diversify to manage risk: Trade only liquid stocks and diversify your positions among various sectors and capitalizations. Diversification is the key to withstanding market volatility, i.e., the gains from a few positions can offset the losses from others;
- Minimize losses with stop-losses: Stop-loss orders are vital in managing risk. A stop-loss order is an offsetting order that gets you out of a trade if the stock reaches a set price. For a buy order, a stop-loss can be placed under a recent low, and for a sell order, above a recent high. Once the stop price is met, it will be executed as a market order at the next available opportunity. By using stop-losses, the trader knows exactly how much money is at risk since the risk of each position is capped at the difference between the current and the stop price;
- Be cautious with leverage: While leverage is one of the most potent tools for magnifying gains, it will also amplify your losses if things go wrong. For example, even a tiny swing in an unfavorable direction in a highly leveraged position can wipe away your entire account balance and result in losses far beyond your initial investment.
Swing trading pros and cons
Beginners should carefully consider the pros and cons of swing trading to decide whether they’re the right candidate for this trading strategy.
- Swing trading is less time-intensive than day trading and, as such, is compatible with those who have full-time jobs or individuals who can’t dedicate hours each day to trading;
- Swing traders can control positions by setting appropriate stop-loss orders;
- Because swing trading is much slower in pace, it might not be as stressful as other active trading strategies;
- By holding positions open for longer, traders can capture the bulk of market swings and thus maximize short-term profit.
- Traders must achieve proficiency in technical analysis to identify entry and exit points, which might take longer than expected;
- Because trade positions are held for more extended periods, they are subject to overnight and weekend market risk;
- Sharp market reversals can result in significant losses;
- Swing traders frequently miss long-term trends in favor of short-term market movements;
- Though not as fast-paced and taxing as day trading, swing trading can still be highly stressful.
All in all, while swing trading doesn’t require the same level of active concentration as day trading, it does demand considerable comprehension of technical analysis, so a knack for charts and numbers is essential, as well as a great deal of practice to gain consistency.
And while trading may present an opportunity for attractive returns in the short term, buying and holding is the surest way to beat the market and achieve your financial goals.
FAQs about swing trading
What is swing trading?
Swing trading is an active trading strategy that involves taking trades that can last a couple of days up to several months to profit from price changes, i.e., swings.
What is the difference between swing trading vs. day trading?
Day traders make dozens of trades in a single day, never holding on to trades overnight. Swing traders, on the other hand, typically hold onto trades for days to several weeks or months.
What stocks are best for swing trading?
The best swing trading stocks will have high price volatility and liquidity, like large-cap stocks, which are among the most actively traded stocks on leading exchanges.
What are the risks of swing trading?
Swing traders are exposed to various risks, particularly gap risk, whereby an asset’s price increases or decreases significantly based on news stories or events that happen while the market is closed (overnight or during a weekend). Moreover, abrupt shifts 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.