What is Swing Trading and How Does it Work?

Typical behaviour of stock market prices is reflected by highs and lows, and swing trading tends to capitalise on this pattern. Movements in stock prices dictate certain trading strategies and swing trading concentrates on the direction of any stock’s momentum and identifies potential spots where the momentum tends to travel.  

Swing trading, while gaining fame, seems relatively less familiar to investors than day trading. Still, it deserves to be known as it can assist traders in achieving substantial success in the financial markets. It offers a distinct, yet common-sense approach to trading, far removed from the conventional rapid pace and volatility of day trading. Delving into swing trading is of the essence since investors can potentially make money and mitigate risks.  

What is swing trading?

In the simplest language, swing trading is a trading and investing process that concentrates on harnessing returns in the financial markets, spread across a short to medium term. The duration of swing trading may last for a few days to many weeks. The strategy involves investors engaging in identifying and making the most of swings in an asset’s price and momentum. Traders and investors make optimal decisions based on technical analysis and estimate, with near-accuracy, when to enter and exit trades. Contrary to day trading where trades are opened and squared off in a single trading session, positions in swing trading are held longer, but not for the same length of time that traditional buy-and-hold investments dictate.  

After you have read this so far, you will be able to answer the question, “What is swing trading?”, but it’s worth noting some more aspects of the concept. By definition, swing trading is the exact opposite of day or intraday trading. Swing trading does not involve starting and closing trades within a day. Typically, swing traders keep their positions while focusing on a larger market share, exerting patience for a prospective deal and then trade in the direction of a trend.  

How does swing trading work? 

Swing trading makes the most of peaks and dips in the stock market, to guide traders with their trading patterns and make decisions based on technical analysis. The method takes advantage of short-term shifts in prices of securities, typically stocks. Swing trading especially concentrates on stocks that portray high activity and dynamic price movements. Swing trading in stocks, or any other securities, can be explained by specific steps:  

1. Choosing Stocks 

The first and vital step to trading, any trading, is to choose the stock to trade. It is essential for investors to opt for stocks that are in the midst of an upward trend. Next, stocks should possess the quality of high volumes traded and market liquidity. For effective swing trading, large-cap stocks may be considered by investors. When the markets are in an active phase, such stocks are prone to fluctuations marked by high and low levels.  

2. Undertaking Technical Analysis 

After picking a particular stock, investors must make a thorough analysis of the stock’s price shifts and patterns. Typically, this is undertaken using technical analysis with tools like the Moving Average Convergence Divergence (MACD), the Relative Strength Index (RSI), trend lines, and volume indicators. Furthermore, remaining informed about vital news and company, industry, and sector developments can offer insights into a stock’s prospects to engage in swing trading proficiently.  

3. Setting Entries and Exits 

After investors have a grip on a stock’s analysis, they can determine potentially optimal entry and exit positions for trading. A common method for doing this is to fix a stop- loss order (approximately 5% less than the price at entry). This is done to keep losses at a minimum. At the same time, a target price may be set, typically around 20% more than the price at entry, so that profits are locked in. Among swing trading strategies, here, the idea is purchasing close to the stock’s support level while selling close to the stock’s level of resistance.  

4. Grasping the Shift 

At the core of swing trading, lies the predicting and understanding of the movement, the “swing”. In the stock market, the swing represents the oscillation of share prices, moving between levels of support and resistance. In swing trading, traders identify these levels and the tendency of the stock to bounce back from levels of support and shift towards resistance with the goal of buying low and selling high within a comparatively short period.  

Why is swing trading important? 

Answering the question “What is swing trading?” accurately, is as vital as knowing why swing trading is a significant way to trade. Swing trading is not long-term investing, and nor is it day trading. You could say that swing trading rests in the middle of day trading and long-term investing. The secret to unlocking profit from swing trading is getting your hands on the correct stock, a stock that is likely to grow in its value in a relatively short spell.  

It is important to be in-the-know that swing traders may have to wait patiently for substantial returns to show themselves. While potentially huge returns may be on their way, traders tend to gain many small gains in the interim and these act as a supplement to their final profits. Hence, they achieve a tremendous volume of returns in terms of profit. However, to reach this stage in swing trading, traders have to maintain levels of stop-loss considered low (2%-3%). Additionally, their profit-to-loss ratio is managed at just 3:1. This is done so that too much is not risked, as a huge loss can erase all the minimal gains.  

Swing Trading vs. Long-Term Investing: Key Differences 

As investors become more savvy with trading strategies, they must also keep reminding themselves about different ways to invest. Swing trading and long-term investing may appear quite similar in some respects, but there are key differences to consider:  

• Investment Timeframe: Swing trading is all about short-run trading, perhaps days to a few weeks. Long-term trading deals with investors holding investments for several years.  

• Influence of Volatility: Swing trading in stocks considers the peaks and valleys of the market, influencing rapid profits. Long-haul investing tends to ignore price volatility of the short-term and holds the long perspective. 

• Stock Choice: In swing trading, stocks are chosen according to technical analysis and short-run trends to make swift returns. Long-term investing involves investing in robust companies with the highest potential for growth, reflective of strong fundamentals and healthy industry reputations. 

• Investment Tactics: Swing traders purchase at low prices and attempt to sell for gains in the short run. Investors with a perceived long-term investment plan purchase stocks of fundamentally sound companies that are bound to evolve in time.  

• Management and Monitoring: Since swing trading is done from a short-term perspective, it requires hands-on monitoring. Long-term investing follows a buy-and-hold model of investment, requiring less constant monitoring.  

• Risk Status: Swing traders aim to make profits in the short run, so they face more volatility risks. Long-term investors hold stocks for long periods and hence, face less risk as robust stocks tide over volatility and ultimately make profits over a lengthy duration.  

• Making Profits: The aim of swing trading is to make comparatively rapid profits in a short span, but long-term investments require you to hold reputed company stock for longer periods, and substantial returns are made with patience.  

Advantages and Disadvantages of Swing Trading 

Swing trading may seem like a simple and no-nonsense strategy but it involves careful execution and advanced analysis. Nonetheless, it has many advantages for traders, along with a few disadvantages, explored below:  

Advantages 

• Swing trading offers traders the possibility of substantial profit-making as it permits traders to take advantage of short-run price momentum.  

• Although swing traders have to make rapid decisions, sometimes trends may be slow to move and this creates decreased exposure to the markets. At these times, traders may not have to constantly monitor trades - trades may last for a few days to even weeks till traders are able to leverage price movements. This also means that swing trading has a flexible nature.  

• Swing trading makes use of technical analysis which is helpful in achieving positive trading outcomes.  

Disadvantages 

• Since swing traders are engaged in several trades, transaction costs may have to be borne quite often. 

• Risks of market volatility are present as swing trading involves rapid trading in the shorter term. 

• As swing traders depend on signals and market indicators to guide trades, sudden circumstances may give them incorrect signals.  

• A crucial pitfall of swing trading is the quick nature and presence of mind that a trader needs for this trading. This may lead to emotional stress and incorrect trading decisions.  

Conclusion 

Investors who wish to trade with trends, in a methodical manner, pick swing trading as their trading strategy of choice. Swing trading may be considered by those traders and investors who fall in the band between not-quite day traders and long-term traders. For those who are starting out in trading, swing trading may offer a balance between the dynamic yet risky intraday trading and the long-waited long-term investment methods. With some research, study, and practice, swing trading may be considered after you align your unique risk potential and financial objectives with this approach.