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Swing trading is a trading strategy where investors buy a stock or some other asset and hold it — known as holding a position — for a short period of time (usually between a few days and up to a several weeks) in the hopes of turning a profit.
The goal of the swing trader is to capture a portion of any potential price movement or “swing” in the market. Individual gains may be smaller as the trader focuses on short-term trends and seeks to cut losses quickly. However, small gains achieved consistently over time can add up to an attractive annual return.
Role of Technical Analysis in Swing Trading
Swing traders use technical analysis, which is the study of statistical trends and patterns on a stock chart, to spot trading opportunities. It’s for this very reason that trading can be as intimidating as it is risky.
As such, technical analysis underpins swing trading as it holds that past trading activity and price movements can indicate future price movements. Swing traders rely on a wide variety of technical indicators and charts to gain insight into market psychology, analyzing multi-day patterns to determine the likely direction of a stock price.
We briefly talked about identifying swing lows and highs in the earlier section. How do you identify these swings? The answer is technical indicators.
Since we want to trade the swings in a trending market, we will use trending indicators to identify these swing lows. One of the simplest technical indicators to use is the moving averages.
You can also use:
- Moving average convergence-divergence (MACD) indicator,
- Williams’ fractal,
- Stochastic indicator,
- Relative strength indicator (RSI),
- On balance volume (OBV) etc.
Now you must be thinking, should you use only one technical indicator?
Actually, you can use a combination of two or three indicators if you want to be sure of the trading signals generated. If you are using two indicators and both give you the buy signal, you will have more confidence in going long, than if only one was used.
However, if you use more indicators, your trading signals might reduce. This is why we try to limit the number of technical indicators to use for swing trading.
How does Swing Trading Work?
The swing trader analyzes patterns in trading activity to buy or sell a stock in order to capitalize on price movements and momentum trends of stocks, typically, focusing on large-cap stocks since they are the most heavily traded. Because these stocks have high trading volumes, they offer investors insight into how the market perceives the company and their security’s price movements. This active trading offers the information necessary for what’s called technical analysis, which we’ll cover in the next section.
As with any style of trading, swing trading carries plenty of risk. Swing traders are exposed to several types of risk, the most common being gap risk, where a security’s price rises or falls significantly based on news or events that occur while the market is closed, whether overnight or during a weekend.
The opening price will reflect the shock of any unexpected news. The longer the market is closed, the greater the risk. Abrupt changes 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.
How to Create a Swing Trading Strategy?
Before you create a swing trading strategy, you should decide which assets you want to trade. Preferably, you can select trending stocks such as Apple, Tesla. Not limited to stocks, you can also look at commodities as well.
Once you have selected the stocks, you can decide on the technical indicators which you will use. In our course on swing trading, we have used the MACD and the Williams fractal as our choice.
A strategy should always be thoroughly backtested before you plan on going live. Make sure that you have historical data of the assets you plan on trading. For example, if you want to trade Apple, you can download the daily historical data for the past 10 -15 years. You can even look at minute timeframe data if you want a closer look at the asset prices.
Once you have the required historical data, you can set the rules of the strategy. The first thing you will do is plan your entry rule.
If you are using the MACD indicator, your entry rule would be to buy when the MACD line crosses the signal line and goes above the signal line.
Apart from the entry rule, the exit rules are equally important. One exit rule will be dependent on your choice of indicators. If you are using the MACD indicator, you can exit when the MACD line goes below the signal line.
You should also have exit rules based on the take-profit and stop-loss levels. Swing traders look for small profits which add up in the long run. So if your asset gives 4% returns, the swing trader will exit the trade.
Also, if your asset price goes in the negative and crosses 2% loss, the swing trader will exit the trade. The take profit and stop loss levels can be decided on your risk to reward ratio. For this example, it was a 1:2 risk-reward ratio. This ratio is subjective and depends on the individual’s risk appetite.
Apart from the above exit criteria, swing traders will typically exit the trade after a month, irrespective of the profit or loss. Recall that swing traders don’t stay in a trade for a long time.
Thus, in this way, you can define the entry and exit rules for your own swing trading strategy.
However, swing trading carries some risks too. Let’s find out the advantages and disadvantages in the next section.
Swing Trading Tactics
Here are some of the most commonly used Swing Trading tactics:
- Fibonacci Retracement: It is a technical indicator based on Fibonacci numbers and allows investors to identify a specific stock’s support and resistance levels.
- Trend Trading: This is a trading style through which investors attempt to realise profits based on the current market trend and the asset’s momentum. Trend Trading is undertaken by investors based on various technical indicators to help them identify the current market trend.
- Relative Strength Index: The RSI is another oscillating indicator that traders use to assess market momentum, market conditions, and warning signs for potentially hazardous price changes. Its value spans from 0 to 100.
- 10 and 20 days SMA: A Simple Moving Average is computed by taking the average price of a security over certain periods. They are usually constructed using the closing price, while it is also possible to calculate it from the open, the high and the low data points.
Advantages and Disadvantages of Swing Trading
As with any other trading option, swing trading has its share of advantages and disadvantages.
- The time required for trading is less.
- The short gains are made consistently over time, which gives you high annual returns.
- It’s a relatively simple trading process and you can use just technical analysis to analyse the trade position.
- Swing traders face overnight and weekend risks.
- Sudden changes in the market can lead to high losses