Investing > What is Swing Trading?

What is Swing Trading?

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Understanding how the stock market works is no easy task.

Many smart people spend decades learning its intricacies and developing strategies with which they can earn fortunes, change the paths of corporations, and gather funding for their retirement.

One of the most well-known types of stock market trading is swing trading, and it’s a particularly good trading strategy to know in times of market uncertainty when prices can spike as often as they drop.

Today, let’s take a look deeper into what swing trading is, how it works, and whether you can use it to make a profit off the stock market even in uncertain times.

What is Swing Trading, Exactly?

Swing trading is trading on the stock market intelligently by using the natural “swings” of the market. Stocks go up or down in price all the time in trends, and with the right tools, these trends can be predicted. The gap (or spread) between a stock’s lowest point and highest point is where the swing trader makes his or her profit. 

Basically, you analyze the general trend of a stock and either buy or sell based on that prediction with the explicit intent of making a profit (based on your gains in stocks) over several days or weeks as opposed to a single day. This is primarily done through technical analyses that look at various price trends and patterns to try to predict the values of certain stocks in the near future.

stocks graph

In stock market parlance, when you hold a position, it means that you neither buy nor sell the stock you have in your portfolio in anticipation of a better time to move.

Swing trading will have you hold a position for “long” or “short” until the opportune buying or selling moment. Holding long refers to someone who has several shares of stock, while holding short means that the same person owes stock to another person based on a prior trade but has not yet purchased the stock itself.

Most swing trading strategies rely on traders holding short or long for no longer than a few months. The ultimate goal of any swing trading strategy is to capture a profit based on projected price movements.

How Does Swing Trading Work?

Let’s go over an example. For instance, a stockbroker could theoretically attempt to purchase certain stocks and sell them within six months for about a 20% to 25% profit.

This would occur within two trades – one in which the stockbroker purchased the stocks in the first place and one in which they sold them later. The overall profit, as mentioned above, would be either 20% or 25%. 

Swing trading focuses on smaller gains because of the shorter time frame. A swing trader will attempt to make a profit within a few days to a couple of months in most cases. The profit goal is to make about 5% or 10% gains based on the stocks traded by buying a stock at a temporary low and selling it at a temporary high. Swing traders choose which stocks to target based on research.

While this doesn’t sound as appealing, you have to consider that you can make multiple trades as a swing trader. For instance, if you could make three swing trading deals that each made 10% profit, you would make more money than a trader that made a single deal over six months for just 20%.

Swing trading is riskier than other types of trading because it can expose the broker in question to both overnight and weekend risk. In other words, the stocks held by the trader in this example could suddenly become worth much less and open at a different rate. Because of this risk, swing traders use risk to reward ratios based on profit targets and points at which they will “cut and run” to minimize their losses.

This allows swing traders to take small losses and continue to make overall profits over the long-term.

Swing trading is popular across the market, especially for those with minds for technical analysis, or those who appreciate betting on the market when they can influence their success chance based on odds. 

Swing Trading vs Day Trading

Day traders are similar to swing traders in goal if not an execution. Day traders almost exclusively execute “intraday” (i.e. taking place within a single day) profit strategies in order to make their money. They use many techniques in order to go about this process.

A day trader is generally classified as a trader that trades four or more times during a five-day span. In fact, many day traders will complete trades in minutes or hours as opposed to days or weeks like with swing trading.

Notably, day traders also close all of their trades before the end of the trading day bell. They don’t hold any open positions overnight, so this limits their efficacy to short-term bid-ask spreads (basically what they can get for an asset based on acceptable buying/selling prices). They may also make money based on trading commissions.

swing trader vs day trader

Many day traders focus on price action characteristics of a stock or assets. They use price volatility and average day range data in order to make short-term decisions on a stock’s potential value over the course of the next few hours. They look at price movement trends, as well as volume and liquidity, in order to capitalize on small profits.

In general, day traders make lots of small profits in rapid succession rather than focusing on big payouts.

The biggest difference between day and swing traders is that swing traders take some unpredictability of overnight risk into account when they make their projections. For instance, a swing trader holding an open position on a farming company exposes themselves to the risk that a disaster might strike during the night. Day traders are not exposed to these risks as they close before the end of the day.

The flip side is that day traders usually make smaller profit margins for all of their deals than swing traders. 

Is Swing Trading Better Than Day Trading?

Neither type of trading is better than the other. It’s arguable the potential for long-term profits may be higher with day trading because of the sheer multitude of deals you can make a profit off of.

But day trading is also somewhat riskier than swing trading because of the same reason; you open yourself up to losses more frequently, which can compound just as reliably as compounding profits.

Swing trading nets you more of a profit or loss per deal you make but it also exposes you to extra risks. In exchange, you get to project your profits more reliably and focus on positions and assets that have longer-term value.

Additionally, day trading requires more of your attention as you have to make more trades every day in order to make your small profit margins all add up. Day trading is closer to a full-time job than swing trading.

How Much Money Do You Need to Be a Swing Trader?

There is no capital minimum you need to become a swing trader. But it’s still recommended that you have some lump sum of capital that makes sense for your position size. It’s a good idea to have at least $5000 in your account if you plan to become a swing trader, although going even higher is recommended.

Think of the math this way: you want to risk 1% or 2% of your account total for every trade you make, at least in the beginning. You’ll also probably risk about $100 for every trade in order to overcome commission fees and to make a reliable profit for every trade. This means that you’ll need at least $5000 in order to account for a risk of 2% with $100 risks.

Swing traders are also allowed to have up to two times leverage in their accounts. This means you can purchase up to twice the amount of stock as the value in your account. For easy math, imagine having $10,000 in your swing trading account; you can purchase $20,000 worth of stock with this account.

The Benefits of Swing Trading

Swing trading provides many potential benefits to those who have the skills and minds to make the most of its advantages. For starters, swing trading takes a lot less time than day trading, which itself requires lots of time spent making multiple trades every day.

It also can maximize your short-term profit by capturing most of the potential profits in market swings. While a “trend trader” (i.e. someone who buys stocks and tries to sell them for maximum value at their peak) tries to capture all of a market swing’s potential over many months, swing traders rely on making most of the profits possible but move on more quickly.

Swing traders also benefit from being able to rely on technical analysis almost exclusively. This simplifies the trading process for them and frees up more time for more strategy formulation, portfolio diversification, or just for other things.

The Disadvantages of Swing Trading

Despite all of its advantages, swing trading does come with several possible downsides.

For instance, many swing trading positions are subject to significant risks, as mentioned earlier. This does open up the swing trader to serious losses, particularly if they experience a run of bad luck or if the market as a whole goes into a deep recession unexpectedly. Many swing traders are likely experiencing significant losses as a result of the coronavirus pandemic. 

Any abrupt market reversal can result in substantial net losses. Like in any other type of gambling, sometimes good luck runs out and the house wins.

Swing traders can also miss long-term trends and potentially greater profits in favor of focusing on short-term market moves. While this isn’t necessarily a bad thing, it does mean that other types of trading can be more profitable as a whole.

Swing Trading Basics and Strategies

The overall goal whenever you practice swing trading is to find an overall trend within a market and capture the majority of the profit gains within that trend before it peters out. This will result in larger gains than you would have earned with a series of successive day trades.

The goal is simultaneously to avoid taking big profits on your positions by overstaying you’re welcome. Essentially, holding onto your stocks for too long so that a hypothetical upward trend goes down is a recipe for disaster. In this case, you’ll end up holding stocks that are worth less than what you originally paid for.

To that end, many swing traders use analytical tools and charts to project trends’ strengths, expected timeframes, and upswing or downswing frequencies. In other words, you can figure out which direction the stock is going in and how long/certain it is to continue.

Swing forex trading strategy

Most swing traders will look at chart patterns. Securities on an upward trend should be purchased by swing traders, intending to ride in the upward trend until it’s time to sell the same shares.

Downward trends could still be profitable; a swing trader could short various shares or futures contracts or buy put options. Put options are investments where the owner of the share has the right to sell by a predetermined date for a certain price.

Alternatively, securities can be on a relatively neutral trend: this is called movement along a parallel resistance. The security’s value could go up and down, oscillating without reaching real highs or lows. You can still make smaller profits off of these cases.

Common Methods Used in Swing Trading

Most swing traders use several common methods to analyze securities trends. But all swing trading methods rely on the flux and flow of the market.

Some swing traders tend to go with the flow, buying stocks at the beginning of a rise in selling them as they reach their maximum peak in value. Others purchase stocks at their lowest point, at the hypothetical pit of a decrease, only to hold them for several weeks or months until they rise again in value to make a tidy profit.

The ultimate goal is to look at the average decreases or increases in a stock’s value as time passes. This involves using the analytical tools mentioned earlier, figuring out stock averages, price percentage decreases or increases, and overall market factors that might affect whether a stock is going to start plummeting or rising again.

Stop Points

Many swing traders also set “stop points” at pre-set prices for a swinging security. This way, they automatically sell the shares of a particular stock if it reaches a certain low point in order to protect their account from total loss. For instance, a swing trader might purchase a stock at $10 a share, expecting the trend to go upward for the next few months.

But they might also place a stopping point at $10 a share. In essence, they’ve set their strategy so that if the stock price goes back to where it was when they initially purchased it, they exit that market and move on to other securities without really losing anything. Many swing traders rely on being able to cut their losses rather than losing all of their capital in a single bad trade.

In this sense, swing trading is rather middling in terms of risk and reward compared to riskier stock trading strategies. A smart swing trader will never bet more than they can afford, but still bet enough that they can make a tidy profit should their predictions and up being correct.

Which Time Frame is Best for Swing Trading?

Swing traders will utilize charts heavily in order to identify average stock trends. The charts can be displayed across several different types of time frames. Different stock traders will have their own favorites, but in general, you want to avoid daily charts because most of your deals will take place over several days at the fastest.

Therefore, stock charts with weekly time frames are a good starting point for short-term swing trading deals. Other time frames that can be great for swing traders include biweekly or multiple week-long charts that demonstrate how a stock can ebb and flow over 20-30 days.

On the other end, few swing traders will take advantage of charts that look at multiple months of progress for a given security. A good hypothetical maximum time frame is three months, after which point you’re essentially acting like a longer-term trader rather than a swing trader.

Swing Trading in Bull Markets

In the stock market, a “bull” market is one in which the general trend is up; prices are rising, confidence is high, and investors are looking to jump in. A “bear” market is the opposite; prices are down, confidence is falling, and general investment is down.

Bull markets provide you with plenty of swing trading strategies to take advantage of.

Although bull markets are often represented in simple graphics as a single, straight line, stocks that are trending upward rarely move perfectly straight. Instead, most stocks move along a set of stairs, repeatedly ascending and descending but with more upward momentum than the reverse. It’s like a zigzag going up.

As a swing trader, you should look for any initial movement that is part of a major upward trend. After noticing a countertrend (when the security goes down in value temporarily before resuming its rise), you could purchase some of the securities at their lowest point on the trend and ride the wave upward to profit.

You can look at the pattern of a rising stock trend and find a good stop out points and profit targets. Look at the lowest point of the counter-trend or pull back, for instance; this is the ideal place in which you should sell your position to limit your losses. If the stock goes this low again, odds are that it’s not on an upward trend anymore.

Then look at the highest point of the most recent uptrend, or rising action. This is where you want to profit. You should consider selling at least a portion of your shares to make a guaranteed profit if the stock price rises to that point once again as it begins to recover from a countertrend.

How can you tell if a swing trade (by trying to estimate the zig-zagging of a stock up and down a rising trend) is worthwhile? Try to target two-to-one reward to risk ratios. Your potential profit should be about twice as much as your potential loss. This guarantees a decent profit without exposing your account to too much risk.

Swing Trading in Bear Markets

There are also strategies you can use in bear markets (i.e. markets that are trending downward) or securities. This way, you can still make a profit even if the stocks aren’t always going up. Just like with performing swing trades on stocks trending upward, you should try to make sure that the stock in question is actually consistently decreasing rather than only experiencing a temporary setback.

Just like with upward trending stocks, downtrends can also move in a stair-like fashion, going in a general zigzag where they generally decrease in value but occasionally spike back up temporary.

This strategy is essentially the reverse of the strategy above. You want to purchase some shares when it’s at a potential peak downtrend, and right before the securities are set to spike back up. Then you sell at the hypothetical or projected maximum spike, right before the shares crash in value once more. You make a small profit on the “little mountainside” of the zig-zag in this way.

Conclusion

All in all, swing trading is just one of the many ways in which you can leverage your positions and earn money on the stock market effectively.

It’s an interesting strategy compared to other methodologies out there because it assumes a relatively balanced position in terms of risk and reward. It isn’t nearly as time-consuming or risky as day trading, but it’s also not as potentially profitable.

Still, many will find swing trading to be a great fit for their personal styles and financial goals. Have you ever used swing trading before with your own portfolio? Let us know and tell us how it worked for your market trades!

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on TheTokenist.io. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

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