Takeaways

Swing trading stands somewhere between day trading and trend/position trading.

Swing traders typically open a trade, hold it for days to weeks, and wait to capitalise on market swings in a direction.

Swing trading depends on market circumstances. Sideways markets make swing trading difficult.

Swing trading depends largely on price action and technical analysis.

Swing traders employ technical analysis to find entry and exit points during a price swing.

Swing traders are vulnerable to gap risk, where a security's price moves while the market is closed.

Introduction to Swing Trading

Swing Trading is a technique that focuses on taking profits from price swings in trends while cutting losing positions quickly. The profits could be tiny, but if done consistently over time, they can compound into outstanding returns. Thanks to swing trading strategies, traders can hold trades for a few days to a few weeks, but positions can be held longer.

What is swing trading?

A swing trader aims to grab a percentage of any potential price movement or "swing" in the market. Individual wins may be less than those for a trend or position trader since the trader concentrates on quality over quantity. Although upside gains on each trade are often higher than those for day traders, the latter trade more frequently and close their positions quickly. A major part of swing trading is carrying out technical analysis to establish areas of support and resistance, and then the fundamental analysis may be used to confirm the logic behind the trade idea. For example, if a trader establishes that a trend is in progress, or predicts a potential trend reversal, then a news event may act as a catalyst for a move. Once the news aligns with the trader's bias, she may wait for a technical signal described in her strategy. Unlike a trend trader who will only open positions in the direction of the overall trend, swing traders are happy to go short in bull markets and long in bear ones.

What to know about swing trading?

Swing trading, like any other trading method, is full of risks. Swing traders face a variety of risks, the most prevalent of which is gap risk, particularly when trading individual stocks. Gap risk is where the price of an asset increases or falls dramatically as a result of news or events that occur while the market is closed, whether overnight or over the weekend.

The opening price usually reflects the after-effects of the news event. The longer the market is closed, the bigger the danger usually is. In addition, swing traders sometimes miss longer-term moves if they focus on shorter holding periods.

Tools for swing trading

Here are some practical tactics and some indicators for swing trading in the markets:

Fibonacci retracements

Fibonacci retracements can assist traders in developing effective price entries. In a trending market, price normally tends to retrace before going in the original direction.

After a market has made a significant move, either up or down, the Fibonacci Retracement tool highlights significant retracements via horizontal lines at 23.6%, 38.2%, and 61.8% of the full low-to-high or high-to-low move. These levels often mark areas that then become important levels of support or resistance.. Swing traders also watch out for the 50% retracement of a move.

A swing trader might enter a trade when an asset's price retraces to the 61.8% level and try to exit when the price hits the 23.6% level. Fibonacci retracements help to establish price thresholds where swing traders may get potential trade opportunities with a good risk/reward ratio.

Support and resistance levels

Support and resistance are the core of the technical analysis. These levels show how supply and demand factors play out in the market and can help to predict the future price movement of financial assets.

Price may decline from supply zones or resistance and rise above demand zones or support. Swing traders will typically try to go long when the market bounces off support zones. In long positions, a stop loss is placed some distance below the support region, with profit objectives around the resistance area.

Similarly, sell trades will be placed when the price declines from a resistance region. Stops will then be put above the resistance region, with profit targets around the support area.

An essential factor to know when swing trading off support and resistance levels is that when the price breaches the levels, support becomes resistance or vice versa. For instance, if the price breaks a support line, the line converts into a new level of resistance.

Ranges and consolidations

Using ranges for swing trading is for fast-moving markets. It is crucial to pick an asset trending aggressively inside a channel. Channels are generally parallel trendlines.

When employing channels, trend traders insist it is crucial to place trades solely in the direction of the main trend. For instance, if the price is heading lower, it is prudent only to go short when the price touches the channel's resistance (upper trendline). Profit targets might then be the bottom of the channel.

But swing traders are happy to sell into an uptrend, and buy in a downtrend. But swing trades may only be placed while the price is contained within the channel. If the price breaks out of the channel, you may need to modify the bias or find a new pattern to help establish the future direction.

Moving averages mean reversion and crossovers

Moving averages are known to smooth out price activity by charting the average prices of an asset over a specific period. For instance, a 20-period simple moving average drawn on the daily chart will indicate the average price for the past 20 days.

Swing traders frequently employ different moving averages to determine dominant price fluctuations in the market. For instance, they may utilise a 20-period exponential moving average (EMA) coupled with a 50-period simple moving average (SMA). When utilising multiple moving averages, the shorter-period one will react to prevailing prices faster than the longer-period one.

Swing traders watch out for moving average crossovers to find good entries in the market. For instance, if the price has been trending higher, but after losing some momentum, the 20-period EMA crosses below the 50-period SMA, it would signal a trend change from bullish to bearish.

Candlestick patterns

As described before, swing trading is heavily reliant on technical analysis. And a wonderful technique to perform the technical analysis is via raw price action analysis. When followed closely, candlesticks may build patterns in the market that can offer potential price movement signals.

Chart patterns

Swing traders typically watch for continuation and reversal patterns. Chart patterns like wedges and flags signal the continuation or reversal of the dominating trend after consolidation. For instance, if a stock is heading lower and a descending triangle emerges on a chart, this may encourage sellers as this pattern can indicate that the price may continue to go lower.

On the other hand, reversal patterns such as double tops and head and shoulders suggest that the momentum of the present trend is weakening, and the price may change direction.

Swing trading in Reversals

Reversal trading is based on a shift in price momentum. A reversal is a shift in the existing trend of an asset. For example, when an upward trend loses momentum, the price begins to fall or vice versa. In any case, a swing trader aims to enter the market after they have confirmed the reversal signal.

Swing trading retracement

Trading retracement means identifying when prices are about to reverse significantly inside a bigger trend. Price retraces to a previous price point (support or resistance in case of a bull or bear trend) before continuing to move in the original direction.

Reversals can be difficult to predict and distinguish from short-term pullbacks. A reversal is a trend shift, but a pullback is a shorter-term "mini reversal" inside an existing trend. Consider a retracement of a "small counter-trend within a strong trend."

One popular method to distinguish between a reversal or retracement is to go on a higher timeframe to establish the major trend.

Swing trading on the Breakout

Breakout trading is a strategy in which you enter a position in a certain direction after a breakout. You enter a position when the price breaks through a critical level of support or resistance.

Why is risk management critical in swing trading?

Risk management is the most important aspect of any effective swing trading strategy. If trading individual equities, traders should focus on liquid markets and diversify their positions across industries and asset classes.

Risk management in terms of risk per trade is an important part of a trading plan. Many successful traders insist that one shouldn’t risk more than 1-2% of their total trading capital on a single trade. The most aggressive and experienced traders may risk up to 5% on each position.

Having sufficient remaining capital in the account allows you to add more positions on winning trades, resulting in greater rewards. Having a good reward/risk ratio in your trading strategy is also important.

Stop-loss orders are an important risk-management tool. When the price falls below the stop loss or rises above, the stop-loss order is executed at the market price, and the position is closed with a small loss. The trader understands how much capital is at risk when stop losses are in place since the risk on each position is restricted to the difference between the current price and the stop price in the majority of cases. However, as we pointed out earlier, there is a risk of prices gapping through stop losses should market-moving news be released while the underlying market is closed.

Final thoughts

Swing trading is an effective trading technique with a lot of upside for intermediate and advanced traders. However, the unexpected can always happen, even with the most rigid risk management. Therefore, you should never risk money you cannot afford to lose.

More crucially, because swing trading does not require the same level of active attention as day trading, the swing trader may begin slowly and gradually to increase the number or size of trades. But doing this requires disciplined risk and money management, together with a thorough understanding of technical analysis.