From Wikipedia, the free encyclopedia
Swing trading is commonly defined as a speculative activity in financial markets whereby instruments such as stocks, indexes, bonds, currencies, or commodities are repeatedly bought or sold at or near the end of up or down price swings caused by price volatility.A swing trading position is typically held longer than a day, but shorter than trend following trades or buy and hold investment strategies that can be held for weeks or months. Profits can be sought by engaging in either Long or Short trading.
Swing trading methods
Utilizing a set of objective rules for buying and selling is a very common method used by swing traders because the rules eliminate the subjectivity, emotional aspects, and labor intensive analysis of swing trading. The trading rules can be used to create a predictive market trading algorithm or "trading system" which can be further defined as a calculable set of trading rules that uses either technical analysis and/or fundamental analysis and results in entry, exit and stop loss trade price points.
Trading algorithms are not exclusive to swing trading and are also used for daytrading and long term trading. Investment in researching trading algorithms/systems has skyrocketed, particularly by investment banking firms like Goldman Sachs which spends tens of millions on trading algorithm research, and which staffs its trading algorithm team more heavily than even its trading desk.
Simpler rule based approaches include Alexander Elder's strategy which measures the behavior of an instrument's price trend using three different moving averages of closing prices. The instrument is only traded Long when the three averages are aligned in an upward direction, and only traded Short when the three averages are moving downward. Trading algorithms/systems may lose their profit potential when they obtain enough of a mass following to curtail their effectiveness: "Now it's an arms race. Everyone is building more sophisticated algorithms, and the more competition exists, the smaller the profits," observes Andrew Lo, the Director of the Laboratory For Financial Engineering, for the Massachusetts Institute of Technology.
Identifying when to buy and when to sell is the primary challenge for all swing trading as well as long-term trend following trading strategies. However, swing traders do not need perfect timing—to buy at the bottom and sell at the top of price oscillations to be profitable. Small consistent earnings that involve strict money management rules can compound returns significantly. It is generally accepted and understood that all mathematical models or algorithms will not always work with every instrument or in every market situation.
Risks in swing trading are commensurate with market speculation in general. Risk of loss in swing trading typically increases in a trading range, or sideways price movement, as compared to a bull market or bear market that is clearly moving in a specific direction.
Introduction To Types Of Trading: Swing Traders by Jason Van Bergen
Swing trading has been described as a kind of fundamental trading (see Introduction to Types of Trading: Fundamental Traders) in which positions are held for longer than a single day. This is because most fundamentalists are actually swing traders since changes in corporate fundamentals generally require several days or even a week to cause sufficient price movement that renders a reasonable profit.
But this description of swing trading is a simplification. In reality, swing trading sits in the middle of the continuum between day trading to trend trading. A day trader will hold a stock anywhere from a few seconds to a few hours but never more than a day; a trend trader examines the long-term fundamental trends of a stock or index and may hold the stock for a few weeks or months. Swing traders hold a particular stock for a period of time, generally a few days or two or three weeks, which is between those extremes, and they will trade the stock on the basis of its intra-week or intra-month oscillations between optimism and pessimism.
Reviewing Different Types of Traders
Before we focus on swing trading, let's review all the other major styles of equity trading:
•Scalping - The scalper is an individual who makes dozens or hundreds of trades per day, trying to "scalp" a small profit from each trade by exploiting the bid-ask spread. (You can read about scalping in Introduction to Types of Trading: Scalpers)
•Momentum Trading - Momentum traders look to find stocks that are moving significantly in one direction on high volume and try to jump on board to ride the momentum train to a desired profit. (You can read about momentum trading in Introduction to Types of Trading: Momentum Traders.)
•Technical Trading - Technical traders are obsessed with charts and graphs, watching lines on stock or index graphs for signs of convergence or divergence that might indicate buy or sell signals. (You can read about technical trading in Introduction to Types of Trading: Technical Traders.)
•Fundamental Trading - Fundamentalists trade companies based on fundamental analysis, which examines things like corporate events such as actual or anticipated earnings reports, stock splits, reorganizations or acquisitions. (You can read about fundamental trading in Introduction to Types of Trading: Fundamental Traders.)
The Right Stock
The first key to successful swing trading is picking the right stocks. The best candidates are large-cap stocks that are among the most actively traded stocks on the major exchanges: Intel, Microsoft and Cisco, for example. In an active market, these stocks will swing between broadly defined high and low extremes, and the swing trader will ride the wave in one direction for a couple of days or weeks only to switch to the opposite side of the trade when the stock reverses direction.
The Right Market
It should be noted that in either of the two market extremes, the bear-market environment or raging bull market, swing trading proves to be a rather different challenge than in a market that is between these two extremes. In these extremes, even the most active stocks will not exhibit the same up-and-down oscillations that they would when indexes are relatively stable for a few weeks or months. In a bear market or a raging bull market, momentum will generally carry stocks for a long period of time in one direction only, thereby confirming that the best strategy is to trade on the basis of the longer-term directional trend.
The swing trader, therefore, is best positioned when markets are going nowhere - when indexes rise for a couple of days and then decline for the next few days only to repeat the same general pattern again and again. A couple of months might pass with major stocks and indexes roughly the same as their original levels, but the swing trader has had many opportunities to catch the short-term movements up and down (sometimes within a channel).
Of course, the problem with both swing trading and long-term trend trading is that success is based on correctly identifying what type of market is currently being experienced. Trend trading would have been the ideal strategy for the raging bull market of the last half of the 1990s, while swing trading probably would have been best for 2000 and 2001. With the 2002 bear market, the best strategy would have been to follow the trend and short everything in sight. As economists and traders would agree, the most accurate insight into trends is viewed in retrospect.
Much research on historical data has proven that in a market conducive to swing trading liquid stocks tend to trade above and below a baseline value, which is portrayed on a chart with an exponential moving average (EMA). In his book "Come Into My Trading Room: A Complete Guide To Trading" (2002), Dr. Alexander Elder uses his understanding of a stock's behavior above and below the baseline to describe the swing trader's strategy of 'buying normalcy and selling mania' or 'shorting normalcy and covering depression'. Once the swing trader has used the EMA to identify the typical baseline on the stock chart, he or she goes long at the baseline when the stock is heading up and short at the baseline when the stock is on its way down.
So swing traders are not looking to hit the home run with a single trade - they are not concerned about perfect timing to buy a stock exactly at its bottom and sell exactly at its top (or vice versa). In a perfect trading environment, they wait for the stock to hit its baseline and confirm its direction before they make their moves. The story gets more complicated when a stronger uptrend or downtrend is at play: the trader may paradoxically go long when the stock jumps below its EMA and wait for the stock to go back up in an uptrend, or he or she may short a stock that has stabbed above the EMA and wait for it to drop if the longer trend is down.
When it comes time to take profits, the swing trader will want to exit the trade as close as possible to the upper or lower channel line without being overly precise, which may cause the risk of missing the best opportunity. In a strong market when a stock is exhibiting a strong directional trend, traders can wait for the channel line to be reached before taking their profit, but in a weaker market they may take their profits before the line is hit (in the event that the direction changes and the line does not get hit on that particular swing).
Swing trading is actually one of the best trading styles for the beginning trader to get his or her feet wet, but it still offers significant profit potential for intermediate and advanced traders. Swing traders receive sufficient feedback on their trades after a couple of days to keep them motivated, but their long and short positions of several days are of the duration that does not lead to distraction. By contrast, trend trading offers greater profit potential if a trader is able to catch a major market trend of weeks or months, but few are the traders with sufficient discipline to hold a position for that period of time without getting distracted. On the other hand, trading dozens of stocks per day (day trading) may just prove too great a white-knuckle ride for some, making swing trading the perfect medium between the extremes.
For more detailed information on swing trading, I recommend another highly-rated book called "The Master Swing Trader: Tools And Techniques To Profit From Outstanding Short-Term Trading Opportunities" (2000) by Alan Farley. Farley's 'pattern cycles' provide intricate methodology and easy-to-understand examples that will enable you to quickly get into the swing of things.
by Jason Van Bergen