Swing Trading: How to Trade the Swing

Swing traders are often called “momentum traders” – jumping into the market when big price moves are occurring, or are potentially about to occur. This method of trading is very popular because it doesn’t have the same capital requirements as day trading stocks. Swing trading involves taking positions that last from a couple of days to a couple of weeks.

Swing Trading 101

Swing trading has been around since the various financial markets began trading, and speculators, such as Jesse Livermore in the early 1900s, attempted to capture big price moves. Futures and options may have made swing trading more prevalent, since these contracts have expiries, and thus require a more robust approach than the classic investor buy-and-hold model.

Swing traders are distinct from day traders, in terms of market approach and legally speaking. Stocks day traders enter and exit positions within the day, and are therefore required to maintain an account balance of at least $25,000 (see What is Day Trading?). Swing traders are not subject to this limitation, nor are day traders in the futures, options or currency markets.

Day traders focus on smaller intra-day moves, while swing traders focus on multi-day price moves. One is not easier than the other; it is all proportionate.

Swing traders also differ from investors. Investors hold stocks for long periods of time, often through multiple ups and down in a stock price. The swing trader focuses on riding momentum, and then getting out before the momentum shifts back in the opposite direction.

All charts created using StockCharts.com

Different Approaches to Trading a Stock
Figure 1. Different Approaches to Trading a Stock

A swing trader will be far more active than an investor, potentially making different trades every couple of days (or every day), while the investor will typically make only a few trades a year. A day trader makes multiple trades each day, and will therefore be more active than the swing trader.

How to Find What to Trade

Swing trading involves finding stocks—or other financial products such as futures, ETFs, options or currencies—that are moving with strong momentum or are about to.

Momentum is the distance the price is able to travel within a period of time. The greater the percentage price movement, the greater the momentum, and thus the greater the profit potential. Swing traders typically avoid quiet, low volume stocks, or markets with little action.

Stocks that have recently had major surprise news releases are often good candidates for swing trades, as the ensuing volatility creates big price moves and the ability to make big gains (but also losses) in a short amount of time.

Also, a stock or market that has a trend, either up or down, may also attract swing traders looking to capitalize on big trending moves. This approach could have been utilized in Figure 2, as there was strong selling momentum on multiple down waves, which could have produced significant gains on short trades, in a small amount of time [see also Top 21 Trading Rules for Beginners: A Visual Guide].

Multiple Opportunities to Short with Momentum During Downtrend
Figure 2. Multiple Opportunities to Short with Momentum During Downtrend

Swing Trading Strategies

Swing traders take different approaches to the market. One method is to trade chart patterns breakouts – triangles are a popular one. The price consolidates during a trend within a defined space marked by trendlines. When the price breaks out of that pattern the swing trader enters the trade, capitalizing on what is likely to be another trending move. Other chart patterns include ranges, head and shoulders, flags, pennants and wedges.

Chart Pattern Breakout
Figure 3. Chart Pattern Breakout

Another popular method is to trade trends that are already in progress. Wait for a pullback and then enter a trade when the price starts to move back in the trending direction. The object is to profit from the next price wave in the trending direction.

Swing Trading with Trend
Figure 4. Swing Trading with Trend

Other strategies include reversal strategies, which may be based on strong support or resistance areas, or candlestick patterns … or both combined.

Candlestick Reversal After Hitting Resistance a Third Time
Figure 5. Candlestick Reversal After Hitting Resistance a Third Time

Risks and Rewards

Swing trading can be highly lucrative, but is can also result in quick losses for those without an established plan.
Swing trading risks include:

  • Difficulty: In hindsight it looks easy, but in real-time the decisions aren’t so obvious. Swing traders often flourish when others are panicking, as the panicking creates big price moves. The problem is that swing traders themselves may get caught up in the psychology of others, causing them to lose their cool, make poor decisions and ultimately lose money. It takes a solid strategy and steady nerves to be an effective swing trader.
  • Price Gaps: It is recommended that swing traders use stop losses on positions in order to limit risk. Unfortunately, even a stop loss doesn’t totally define your risk. When holding trades overnight, the price could “gap” from the prior close to the next open. This means you may experience a loss bigger than anticipated if the price gaps against you. A stop loss, once reached, typically fills at the next available price, which could be very different from one day to the next. This is why a gap can result in increased risk.
  • Losing Sleep: Swing traders hold positions overnight, sometimes for weeks, in volatile conditions. Not everyone is able to handle this. If you can’t sleep with trades on, then swing trading may not be right for you. You may also wish to decrease your position sizes so that the fear of losing, or anticipation of winning, isn’t as strong and won’t keep you up at night.
  • Leverage: Leverage isn’t only for day traders. Swing traders can also typically receive 2:1 leverage, meaning only 50% of the purchase is required up front when making a stock trade. Leverage allows you to make and lose more money, so it must be treated with respect.

Swing trading benefits include:

  • Freedom: Swing traders aren’t tied to their screens all day like day traders. They can typically monitor the market for some time each day, put out their trades, stop losses and targets, and allow the market to fill their orders.
  • Price Gaps: A risk and an advantage. If you on the right side of the trend, gaps will often occur in your favor, which means big gains in a short amount of time.
  • No Capital Requirements: You only need enough capital to trade; there are no set minimums for what is needed (may vary by broker). If you trade lower priced stocks, or futures or options, your capital requirements could be substantially less than the $25,000 required for day trading stocks. That said, you still want to make sure you have enough capital to accommodate market fluctuations, and the risk on trades should only put a small percentage of the account capital at risk.

The Bottom Line

Swing trading involves holding typically high momentum stocks (or other financial asset) for a couple days to a couple weeks. The goal is to exploit momentum, capturing the bulk of move, and getting out before the price reverses course. Swing trading can be utilized in all markets, and offers freedom as it doesn’t need to be time consuming. There is no minimum capital requirement (may vary by broker) for swing trading. While there are multiple methods you can use to swing trade, it isn’t easy. Swing traders need to keep their cool when others are panicking, and need to be able to sleep like a baby even with trades on overnight.