What is Swing Trading?

Swing trading is like driving a race car…

Getting behind the wheel of a sports car usually fulfills a purpose beyond just getting from Point A to Point B. Getting to Point B might ultimately be the goal, but you want to get there as fast as possible and have some fun along the way. Driving a racecar (swing trading) requires more skill, effort, and focus than taking the bus (passive investing). It’s also more exciting to many people. But it comes with much more risk.

While the market as a whole has tended to grow over longer periods of time (10-30 years), individual stock prices spend a lot of time going up and down. A buy and hold strategy passively is designed to benefit from general price increases over time. Swing trading, on the other hand, is an active trading style that looks to profit from those ups and downs (swings) in the market. For instance, if a stock’s price falls for a few days, then recovers back to the previous level, that swing could represent a profit opportunity.

Swing trading isn’t as active as day trading (which buys and sells a stock on the same day), but swing traders rarely hold a position for more than a few weeks. The idea behind this strategy is to play a short-term trend. A perfect swing trade would buy just as the stock price starts a new trend, then take profits right when the price reverses course. As in all investing, additional developments could negate any strategy and result in investment losses.

Swing trading works by capitalizing on the short-term swings in the market. Consider this hypothetical example. A fictional company has steady earnings in a stable market. Its common stock trades for $10 per share on the stock market. But that stock price doesn’t just sit at $10. For a few days, maybe investors push the price up to $11. Since the company hasn’t changed anything about its earning potential, other traders see the new price as overvalued and sell it. That might push the price down to $9. But now the stock could be perceived undervalued. Certain value investors may pick up the ‘cheap’ stock, which could move the price back up.

You can imagine this scenario playing out over and over. The stock’s price action is bouncing in a certain range but never getting too far from a specific value. Holding this stock long-term may not generate a lot of profit if nothing changes. Some swing traders may believe that the value of the stock would move up and down from day to day, even though it wouldn’t really change over time.

A trader might be able to profit if it swings between these lows and highs. In this oversimplified example, a swing trader could buy the stock each time it fell to $9 and sell it once it reaches $11. In theory, this trader could keep buying the bottom and selling the top over and over again until the pattern ceases. Even though the real value of the company isn’t changing, they could profit as the price swings around that real value. Of course, the market is not static over time so likely this pattern will break down either through fundamentals changing or other investors trying to take advantage of the same thing and diluting the profit potential.

The most popular swing trading strategy is to look for stocks that are oscillating within a somewhat stable price range. In general terms, the price goes up until traders aren’t so sure the company can support a higher valuation. Then, the rising price trend hits resistance, sputters, and falls. At some lower prices, traders think the company can support a higher price than its trading for. So, the downward trend loses momentum, hits a level of support, and starts rising.

These cyclical periods of rising and falling prices might offer an opportunity to profit. Parallel support and resistance levels would provide potential entry and exit targets. Of course, trading in the real world isn’t nearly as clear and predictable as we might wish it was. Still, the idea that prices can bounce back and forth around a somewhat average value is the siren song to many hopeful swing traders.

A swing trading strategy that purchases shares whenever the price is a predetermined amount below the average, then sells it when it was a certain percentage above the average, is an approach a swing trader might attempt. Of course, a good swing trader would also incorporate protective stop-loss orders (automatic sell orders if a price falls too far) into that strategy.

Ultimately, there’s probably not a “best” strategy. Each swing trader creates a strategy that balances their risk tolerance and the potential reward, along with the amount of time, effort, and commissions involved. But effective swing trading strategies probably involve looking for these types of price swings to make a profit.

No one can predict the future movements of stocks. All investing carries risk. Always keep investment objectives in mind.

Swing traders are usually looking for reversing price movements. They typically try to buy just as a downtrend bottoms out and sell right as an uptrend tops off. Because of this, reversal indicators are essential in swing trading. Candlestick and other charting patterns that show a possible reversal might be useful indicators.

Technical indicators of support and resistance levels are imperative. Some support and resistance level indicators are easy to spot. But what is very difficult is finding accurate indicators over time. For example, parallel levels are simply the highest and lowest traded values within a specific timeframe. Moving averages can also serve as support and resistance indicators when a stock’s price is trending up or down.

Moving average crossover points are instructive to many swing trading strategies. In general, traders might conclude that breaking through a moving average is a signal of a new trend starting.

The relative strength indicator (RSI) is yet another tool that swing traders can use to identify possible entry points. The RSI measures momentum, which might indicate whether a stock is overbought or oversold.

Finally, volatility is vital to understanding how much a stock’s price tends to move up and down — which provides the information needed to determine the potential risk and reward of a trade. Standard deviation is a commonly used volatility metric to set expectations for how far a stock’s price might move.

There are a vast number of technical analysis tools and indicators that provide different information and insights for traders to use. No strategy is perfect, and no single indicator is best. Most swing traders develop their own methods as they gain experience and exposure to many different tools and methods.

Both swing trading and day trading are active investing styles. But day trading is more involved than swing trading. Day traders make multiple, fast trades in a single day. They often buy and sell the same stock within minutes or hours. Swing traders aren’t moving quite so fast. They are looking for swings in a stock’s price, allowing them to take advantage of buying low and selling for a profit.

Swing trades usually last about a week, but a trader might hold a position longer if a situation warrants it. Either strategy can be profitable but is also risky. The biggest challenge to these active trading styles is consistently beating the market.

Swing trading can be exciting, but it’s also time-consuming and comes with elevated risk not appropriate for most investors. Swing traders might enjoy the active participation, potential financial gains, and the thrill of having a trade pay off. But not every trade is profitable, and many lose money over time. When things don’t work out, it can be emotionally and financially painful.

Swing trading requires active participation on the trader’s part. Traders need to understand the companies they are trading, why other investors are valuing them above or below the average price, and what information might change investor sentiment.

Swing traders also need to dedicate time to understanding how to read charts, value statistics, the various types of buy and sell orders, and financial statements. All this time adds up. Even a profitable swing trader might earn less than minimum wage for their efforts.. Many end up with less money than they would have made if they had simply put their investment in an index fund.

It is also worth noting that professional traders may use algorithms to act on reliable signals much faster than human traders can move. Therefore, an opportunity you identify could very easily close before you have a chance to cash in on it. Still, many traders swear by technical analysis and charting, or just thoroughly enjoy the excitement of trading stocks.

Swing and day trading is for experienced traders who understand and accept the risks involved.