Swing trading focuses on medium-term investment strategies and attempts to make profits when the stock goes up, and when it comes down – hence the term "swing".
This kind of investment strategy – in terms of longevity of trade – sits somewhere in between day trading and buy-and-hold investing.
Day trading is the most speculative of the investment strategies where a stock is held for less than one day, sometimes for only a few hours or minutes, even seconds. Day traders capitalise on short-term moves in assets – selling at a certain pre-defined level to avoid the risk of counter moves during out-of-hours trade.
Buy-and-hold – or trend investing – is a long-term strategy, where investors follow a particular trend: perhaps a cyclical rally to benefit from rises in stocks most closely allied to a strengthening global economy, or perhaps a "growth" strategy focusing on those stocks that pay the highest dividends.
Inside swing trading
Swing trading is medium-term strategy – usually over a few days, up to about three weeks – where the investor follows surging and fading fortunes of an asset or assets, investing in both the gains and the losses.
"Financial markets never go in one direction forever, and by being able to take advantage of that, you can increase your returns as you in theory are going to be making money when the market rises over the next few days, and then make some when the market pulls back, as it will certainly do sooner or later," says Christopher Lewis of DailyForex.
Being able to spot the turnarounds is important and technical analysis will be able to help here, but the best aid to this type of investment strategy is a market that's going nowhere.
In other words, a rangebound market that has been showing the same trends for several weeks. No shocks such as unexpected interest rate moves, or market intervention by monetary authorities.
In terms of participation, swing trading is also more balanced between the full-time participation rate of day traders and the invest and wait of trend investing, so practitioners can hold a full-time job while engaging in swing trading.
How to swing trade
Everyone wants to identify swing trading strategies that work. If only it were that easy. In hindsight, the stock market correction in January and February provided some good conditions for a swing trading strategy, although volatile markets are more likely to work against swing trading (see "disadvantages" below). A correction is when an asset, index or other price indicator falls more than 10% from its most recent cyclical peak.
Choosing the stocks to follow was not difficult, given the wide agreement that technology stocks were among the most overvalued. During the correction, the S&P 500 technology sector fell 10.4%.
Energy stocks, however, proved the worst-performing sector during the correction as oil prices also went through their own downturn. The S&P 500 energy sector fell 14.6% in the four weeks to 9 February.
Of course, the swing trader would not have been likely to catch all of the downside, but the signals that a correction was under way would soon emerge. It would have been catching the upside after the correction ended that posed the most difficult problem in market timing.
Simple moving averages wouldn't tell much during the turbulent trading seen at the beginning of 2018, but signals derived from EMAs, where more weight is devoted to the most recent data, would have been useful. Depending on the trader’s investment strategy, 15- and 60-minute, daily and weekly EMA charts are used.
The chart below is from the S&P 500, which could have also been traded on electronic platforms.
"For traders looking to trade with swings, or traders looking to deepen their identification of market swings, the fractal indicator can be of great assistance," says James Stanley, currency strategist at DailyFX.
Pros and cons of swing trading
Let's examine the advantages and disadvantages of swing trading.
- Markets never go in the same direction all the time, and swing trading allows the investor to take advantage of this, increasing potential returns by backing the rally and the pullback
- It's not a full-time pursuit: unlike day trading, where you must be on top of all your trades every minute, with swing trading you relax a little more as you've set your investment to run over the course of several days. You can swing trade while carrying on with a full-time job
- It's also less capital intensive. You may have several trades going on at the same time, but you're not constantly in the market like day traders and having to come up with new margin for new positions, or have a lot of capital tied up over a long period like buy-and-hold investors
- Bad trades can be limited. Using the appropriate technical signals, you should know when a trade isn't working more quickly and limit the damage done
- Market volatility. Volatile markets are not necessarily the best conditions in which to practise swing trading because if you get the signals wrong, all previous profit can be wiped out in a matter of seconds
- Similarly, you can't always trust your instinct following the trends. While markets often display lengthy periods of rangebound trading, they are fickle and you must not assume that the support and resistance levels you've identified will hold today
- Using fractals isn't enough. You must be properly tuned in to technical analysis to make this work and that means study
- It's stressful. Maybe not as nervy as day trading, but you've still got to have a cool and considered mindset that's not prone to being spooked easily
This is not the strategy for everyone. Even some buy-and-hold investors get spooked when the market is in turmoil, but they know that if it's a good asset it will bounce back and continue to make money for them.
The more often you are in the market, the more likely it is you're going to make a mistake. Get used to losses, because you're going to have unsuccessful trades. Even the most learned analytical investors cannot be right all the time. This goes double for day traders.
But given the right kind of support from your knowledge of technical analysis (and you can read many introductions and explainers right here) this is a strategy that can work.