Investors have different objectives when they enter the stock market. While some trade for quick gains, many people invest for the long term with the goal of building wealth over time. Many others do both. While there are many different trading tactics, swing trading is one of the easiest for beginners to learn.
Swing trading is slower than day trading, which is a very fast-paced trading environment. This approach is an excellent method for becoming familiar with technical analysis and understanding market movements. What the interested trader should know is as follows.
What is Swing trading?
In swing trading, investors purchase stocks or other assets and keep them, also referred to as holding a position, for a brief period of time (often a few days to several weeks) with the goal of making a profit.
The aim of the swing trader is to seize a part of any possible “swing” or fluctuation in prices inside the market. Because the trader is more concerned with short-term trends and wants to quickly eliminate losses, individual gains could be less. On the other hand, incremental profits made steadily over time can build up to a desirable annual return.
How does Swing Trading work?
The swing trader, who often concentrates on large-cap companies since they are the most actively traded, examines patterns in trading activity to decide whether to buy or sell a stock in order to profit from price changes and momentum trends of equities. Due to their huge trading volumes, these stocks provide investors with valuable information on how the market views the company and the movements in its security price. The data required for what is known as technical analysis—which we’ll address in the following section—is provided by this active trading.
Like any trading strategy, swing trading is very risky. Swing traders face a variety of risks, the most prevalent of which is gap risk, which is the possibility that a security’s price would move sharply higher or down in response to events or news that breaks while the market is closed, whether it be over the weekend or overnight.
Any unanticipated news shock will be reflected in the opening price. The danger increases with the length of time the market is closed. Another risk is that swing traders may miss out on longer-term trends by concentrating on shorter holding periods. Abrupt shifts in the direction of the market can provide a risk.
Example of Swing Trading
Let’s examine a practical example of how a swing trader can evaluate Amazon’s stock and decide whether to purchase or sell.
The “cup and handle” consolidation pattern, in which the handle points slightly downward and the cup is u-shaped, is depicted in the candlestick chart above. It is thought that this pattern is a bullish signal.
A swing trader would probably buy Amazon stock at the top of the “cup,” or at or above the most recent high of $3,555, if they wanted to make a profitable trade. They ought to initiate a stop-loss order at the cup handle’s most recent low ($3,395). Consequently, the trade’s risk, or the maximum loss, is $160 ($3,555 – $3,395 = $160).
You’d need to sell at $480 (3 x $160 = $480) above the entry price, or $4,035 ($3,555 + $480), to achieve the good reward/risk ratio of 3:1.
Why risk management is critical in Swing Trading?
The most important element of a successful swing trading strategy is risk management. Traders ought to select only liquid stocks and spread their holdings across a range of industries and market capitalizations.
Risk management is crucial, as highlighted by InterPrime Technologies’ head of capital markets Mike Dombrowski, who states that “each position should be roughly 2%-5% of total trading account capital.” Professional and most aggressive traders can trade up to 10% per position. Thus, an average portfolio consisting of five concentrated swing trades would account for 10%–25% of the total capital in the trading account.
Keeping money on hand enables you to increase the size of your winnings by adding to the trades that are performing the best. As usual, limiting losses is crucial when swing trading.” He adds that a 3:1 ratio—that is, three times the amount at risk—is a desirable reward/risk ratio.
The use of stop-loss orders is essential for risk management. The stop-loss order becomes a market order that is executed at the market price when a stock moves below the stop price (or rises above the stop price for a short position). By implementing stop losses, the trader can precisely determine the amount of capital at risk, as the risk associated with each position is confined to the difference between the current price and the stop price.
Using a stop loss is a good strategy to control trade risk.
Swing Trading Strategies
In order to decide when to buy and sell using technical analysis, traders can utilize a variety of strategies, such as:
- Moving averages look for bullish or bearish crossover points
- Support and resistance triggers
- Moving Average Convergence/Divergence (MACD) crossovers
- Using the Fibonacci retracement pattern, which identifies support and resistance levels and potential reversals
Moving averages are also used by traders to identify a price range’s support (lower) and resistance (upper) levels. An exponential moving average (EMA) emphasizes recent data points more than a simple moving average (SMA), which is used by some.
For instance, a trader looking for crossover points might use the 9-, 13-, and 50-day EMAs. An upward trend in stock price is indicated when it “crosses” or moves above the moving averages. It is a bearish signal for the trader to exit long positions and possibly enter short ones when the stock price drops below the EMAs.
Extremes in the market increase the difficulty of swing trading. Actively traded stocks don’t move up and down within a range in a bull or bear market the same way they do in more stable market environments. The market will move up or down for a while depending on momentum. “[Traders should] always trade in the direction of the trend, taking long positions in bull markets and shorts when the markets trend downward,” Dombrowski advises.
Bottom Line
Swing traders usually start with $5,000–$10,000, though less is acceptable, and it’s a simple way for novice traders to get their feet wet in the market. The guiding principle, however, is that the investor should use capital that they can bear to lose. The unexpected can happen even with the tightest risk management.
More significantly, swing traders can begin slowly and gradually increase the number of trades they make because swing trading doesn’t require the same degree of active attention as day trading. However, it does necessitate a deep dive into technical analysis on the part of the investor, so a knack for charts and numbers is required.
Swing trading presents an opportunity for traders who are prepared to invest time in learning technical analysis and conducting thorough stock research to gradually but steadily build up sizable profits over time.
