What is Swing Trading? Definition, Strategies, and Example 2022

What is Swing Trading

What is Swing Trading?

Swing trading is a short-term strategy involving buying a financial instrument and selling it within days, weeks, or months to make small, incremental gains.

Gains as a result of this strategy can range from 5% to 7% per trade. You might be tempted to think that this is paltry in comparison to, say, long-term investing where the returns could go beyond 12-15%.

But a swing trader can make 5% to 7% per trade, meaning their overall returns could be even higher when taking all trades into account. This is great but what about the elephant in the room?

We’re talking about the “swing” in swing trading. You see, price fluctuations are a common theme in the financial markets.

Swing Trading

What is the objective of swing trading?

Swing trading is a trading technique whose main objective is to buy or sell a stock within a short period, ideally within just one day. A swing trader usually tries to find stocks showing some trend and enters into the trade at the beginning of the trend. In most cases, a swing trader would also try to exit the trade at an early stage.

Swing traders seek to hold their positions for an average of 2 days to a few weeks, making swing trading an excellent way to trade in a bear market. Swing traders also take advantage of market momentum. There are two types of swing trades:

1) Counter trend swing trade – selling or buying into resistance or support areas in the direction of the primary trend (for example, selling into support during an uptrend).

2)Trend following swing trade – buying into support or selling into resistance in the direction of the minor trend (for example, buying into support during an uptrend).

ALSO READ: Risky Mutual Funds You should Avoid in 2022

How does Swing Trading work?

A swing trader will typically look for high-volume (lots of activity) and high-volatility (lots of movement) stocks. Volatility is usually measured by how much the price has moved over time (usually one year).

1. Pick a stock

The first step is to find a stock that can deliver good returns in the short term. You can pick any security you want, but you must have good knowledge about the fundamentals of that security.

2. Analyse its chart

Once you have identified security, analyze its chart with various indicators like Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), Volume and Trend Lines, etc., to understand how it has been performing historically. You should also read news articles about the company and industry news to understand what could affect its performance in the future.

3. Set up your entry

Place a stop-loss order at 5% below your entry price and set a target price at 20% above your entry price. A stock will typically bounce off its support level and move upwards before dropping after reaching its resistance level. This movement up and down is known as a swing. A swing trader takes advantage of this movement by buying at the support level and selling at the resistance level.

What are the opportunities for swing traders?

Swing traders have many opportunities within a trend, but taxes and commissions can cut into profit potential. Swing trading is the skill of reading a price chart and analyzing the footprint of the swing highs and lows made by the market to forecast price direction accurately.
Swing trades are usually held for more than one day but shorter than trend trades. Positions are closed out within three to four weeks.

Trend traders look for successive higher highs or lower highs to determine the trend of a security. By contrast, swing traders use various measures to quantify the short-term trend and exploit that information for profits. A swing trader might use 50-day, 100-day, and 200-day moving averages (MA) to define the primary uptrend or downtrend and a secondary reaction rally or pullback within it.
While there are several opportunities during each week in swing trading, not all of them will be profitable.

Best Indicators for Swing Trading

A technical indicator is designed to help you trade by analyzing or forecasting trends, volume, and other important factors.

The process of using technical indicators to analyze security is known as technical analysis.

Considering these are super important for swing traders, we’ve compiled a list of the best indicators for swing trading.

  • Relative Strength Index (RSI)
  • MACD
  • Moving Averages
  • Volume
  • Bollinger Bands

Pros & Cons of Swing Trading

Pros of Swing Trading Cons of Swing Trading
Simpler than day trading Prone to overnight and weekend risk
Potentially lucrative in the short term May miss long-term gains and trends
Uses technical indicators & analysis Timing the market can be difficult

Things to Remember When Swing Trading

Applying any strategy in the real world has its pros and cons. Moreover, it has implications in the form of commitment (time, effort, and both).

When you’re swing trading stocks, for example, you’ll have to ensure that you have a trading setup that’s designed to carry out smooth and efficient short-term trades.

In fact, you should know the following things before you get started with swing trading:

  • Risk Profile
  • Technical Analysis
  • Position Size
  • Market Conditions

1. Risk Profile

Your risk profile is what determines your ability to participate in the markets. It’s a measure of the risk you can handle, more simply, the amount of money you can afford to lose.

While there are multiple factors that determine risk profile, age and income are known to be the primary drivers. Think of the following personas:

  1. Mr. Rakesh Sharma aged 29 with an income of Rs. 50 LPA.
  2. Mr. Karan Khanna aged 21 with an income of Rs. 5 LPA.

Who do you think can afford to lose more? The thing is, any answer would be incorrect because we don’t know their liabilities (family, rent, loan, etc).

That’s why it’s important to thoroughly analyze your risk profile before entering the markets, not just while swing trading.

2. Technical Analysis

Across this story about what is swing trading, we’ve discussed the role of technical analysis – it’s the bedrock of the strategy. That’s why it’s important to understand how technical analysis works.

Broadly speaking, you’ll have to employ technical indicators like Anchored VWAP, Bollinger Bands, RSI, and others.

P.S: Technical analysis has got everything to do with trends, patterns, momentum, volume, and much more, but nothing to do with fundamentals. This is an important distinction.

3. Position Size

Your position size will be a product of your risk profile. However, you could have a predetermined risk percentage per swing trade or for your overall capital.

For example, Mr. Rakesh Sharma could have a starting capital of Rs. 10,00,000 and could risk:

  • x% of his capital per trade
  • Whatever his risk profile determines

4. Market Conditions

We’ve spoken about how too volatile or too weak markets are less than ideal for swing trading. Just like spring is the ideal season for going on vacations, you’ll have to find the “spring” of the markets.

That said, there are traders who enter swing trades during extremely volatile markets. But these are generally seasoned practitioners of the trade.

Is Swing Trading a Good Strategy?

Swing trading is a strategy that falls between intraday trading where positions are squared off in the same trading session and long-term investing where positions are held for a year or longer.

It has its pros and cons when it comes to wealth creation and execution. Compared to intraday trading, swing trading is a low effort but the profits it may generate are relatively less per trade.

However, swing trading is typically known to be a good strategy to follow for those who want to transition from long-term investing into pure trading principles like day trading or scalping.

Happy Trading!

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