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What is Swing Trading

Swing trading is a short-term market timing approach based on the economic axiom that “price seeks equilibrium” (Farley, 13). As the name implies, swing trading involves attempting to take advantage of price swings in a traded instrument for the purpose of making a profit. While theoretically swing trading is not governed by time but by analysis of the behavior of the stocks (or other instruments) themselves, the indicators that swing traders use to buy and sell cycle often enough for it to warrant the label short-term and practically speaking fall closer on the continuum to day trading than to buy and hold investing which can be held for years or even decades.

Swing trading is differentiated from day trading and buy and hold investing primarily by the amount of time the trading position is held. Swing Traders hold a trading position for a period of a couple of days to a couple of weeks. The holding period can vary and is dependent on the goals and risk tolerance of the individual trader. Though the practice of swing trading can be used in various types of markets and instruments such as stocks and shares, bonds, Foreign exchange (Forex) and commodities, it is most commonly used in stock market trading. In order to make a profit, stock traders must buy a stock at a lower price than when they sell it. Swing traders attempt to profit by predicting the point of support (when buyers outweigh sellers and support a particular price) or resistance (when sellers outweigh the buyers to stop prices from rising) which ensures the greatest swing in price and therefore the best returns.

As with all short-term trading models, swing trading is heavily dependent on timing and quick execution of trades. Swing traders usually use a brokerage account to execute trades on their behalf on the stock exchange in which the stock is being traded. The amount of time it takes for a requested trade to be made can make a great difference in the amount of profits a swing trader accrues. Conversely, responsive service by a brokerage can be a great benefit for a trader employing this method.

Why Swing Trade?

Investors are attracted to swing trading for several reasons.

First, it offers the possibility of making more profit in the same period of time than just buying and holding a stock. Swing traders take advantage of shorter term gains or losses and by buying and selling at specific times, maximize yield (finance). Second, swing trading as a shorter-term practice driven by expected swings in the price of stocks or other instruments, affords the investor the ability to make money in bull or bear markets since buying and selling occur in both. Third, by carrying out a specific plan driven by chart data and fundamental analysis (see below) rather than pure emotion or market momentum, swing trading offers a concrete way to anticipate what a particular stock will do and therefore what is the most appropriate action to take.

In addition, swing trading generally attempts to enter a position either at support or resistance to maximize the return (finance). As with all short term trading, the inherent risk is usually proportional to the expected return and though swing trading proponents who are experts at swing trading expect consistent returns, this is not guaranteed. The graphic below shows the difference between the total profits accrued by buying and holding 100 shares of Intel with the profits accrued by swing trading 100 shares of the same stock in the same period.

(Note: If using a broker, the cost of the trades themselves will be higher in the swing trading scenario than in the buy and hold scenario. See chart below under Who Should Swing Trade?)

[GRAPHIC: Swing trading Comparision http://www.swingtraderguide.com/images/comparison.png]

Trading Mathematics

Profitability in speculative activities like swing trading are governed by simple mathematics. For trading this primary statistic is Average profitability per trade(APPT). APPT measures the average amount a trader can expect to win or lose per trade based on historical trading results.

Average Profitability Per Trade = (Probability of Win x Average Win) - (Probability of Loss x Average Loss)

[GRAPHIC: http://www.swingtraderguide.com/images/equity.png]

[GRAPHIC CAPTION: This chart shows a simulation of 100 different accounts that experience wins and losses at random but with the exact same win/loss ratio and winning percentage for 453 trades each. The lines on the chart represent the resulting equity of each account. If most of the equity lines are above the starting point then the trading method is considered robust and will have a higher probability of being profitable in the long run.]

Trading methods

When attempting to identify opportunities for swing trading, traders generally consider two types of analysis methods, technical analysis and fundamental analysis.

Technical analysis involves the use of price charts and technical indicators to identify entry and exit points of a stock. There are many methods used to speculate in the stock market from a swing trading perspective, however almost all methods can be categorized into two main types; channeling or breakouts. Channeling involves trading methods that attempt to anticipate when a stock will meet support or resistance and turn in the opposite direction. Channeling uses several types of charts analyzing different data in different ways to determine this. The charts are technical but give a graphic look at the behavior of stocks and many software programs are available to the trader to analyze the information and feed it to a computer quickly. Conversely breakouts attempt to enter a market when the stock reaches a new high (for long trades) or new low (for short trades) for a chosen period of time. Breakout systems use information such as the average return over a given holding period after a breakout and the percentage of time the market moves in the direction of the breakout over a given holding period in an attempt to predict high yield.

Fundamental analysis involves analyzing the underlying fundamentals of a stock such as PE ratio, earnings, revenue, management, competition etc. to determine if and/or when it should be bought or sold. If a company has bad fundamentals, obviously it should not be bought in the first place. But most of the time fundamental analysis in swing trading deals with the change in fundamentals of companies that have (or had) good fundamentals or the trader would not have had interest in the stock to begin with. A change in management, for example, could prompt a trader in the direction of selling or buying depending on the perceived ability of the new leader or leadership team. Some traders utilize both analysis methods in an attempt to improve their trading results and predict swings with a higher level of accuracy.

[GRAPHIC: http://www.swingtraderguide.com/images/wikipediachart.png]

[GRAPHIC CAPTION: Moving aveages are a very popoular technical analysis method used by traders. The chart is interpreted by looking for a Long trade opportunities when the short term moving average is a above the long term moving average and vice verse for Short trade opportunities.]

Swing Trading Risks

Like most speculative endeavors there is risk associated with swing trading. Though risk cannot be completed eliminated it can be managed.

The first and most basic risk in swing trading is the risk of abandoning the charts for an emotional, momentum based reason. According to Pring “All things being equal, trading success is inversely related to emotional stimulation.” (Pring, 195). The successful swing trader sticks to the numbers and does not necessarily follow the crowd as it is exactly the behavior of the crowd that the swing trader attempts to predict and press to their advantage. While swing trading may have periods of frenetic activity, there may also be periods of relative calm and a swing trader must be willing to let the data determine when to wait and when to immediately execute trades. More specifically, swing traders manage risk in five ways:

1. Assuming risk – A trader assumes risk by entering positions or by not entering a position. The second scenario assumes the risk of “lost opportunity”

2. Avoiding risk – A trader avoids risk by not entering the market at inopportune times

3. Transferring risk – A trader transfers the risks to others when he exits a trade

4. Reducing risk – A trader reduces the size of his position or uses stop-loss orders to reduce risk

5. Distributing risk – A trader distributes risk by trading a number of individual instruments vs. just one

Who should swing trade?

Speculative trading of any type carries financial risk of loss of funds therefore only discretionary funds that an individual can afford to lose should be used. Traders with larger accounts will usually have more success with swing trading than those with smaller accounts since small accounts will tend to be consumed with inevitable losses as well as commission costs over time. The table below shows how commissions can be a substantial cost for a trading account starting with less capital. Traders also must pay careful attention to their brokers commission per trade as some price trades higher at a lower volume or number of trades per month.

The table below shows how commissions can be a substantial cost for a trading account starting with less capital.

Account Balance	Number of trades	Commission per trade	Total commission cost $	Total Commission as a percent of account balance
$25,000	150	$5	$750	3%
$5,000	150	$5	$750	15%

Authoritative Sources

Though there is much written about the subject of swing trading, there isn't a single authoritative source or reference. This is probably due to the “opinionated” nature of market speculation in general. Theoretically, the most authoritative source for swing trading are the charts and fundamentals of the stocks themselves. These technical and fundamental analysis tools are now readily available and though technical in nature are also graphic in nature thereby showing trends at a glance. Additionally, there are many sources available to more fully introduce swing trading and give greater insight into the understanding of the charts and company fundamentals. What follows is a truncated list of relevant sources and articles.

References

Achelis, Steven B. Technical Analysis from A to Z, 2nd ed., McGraw-Hill, New York: 2001.

Farley, Alan S. The Master Swing Trader: Tools and Techniques to Profit from Outstanding Short-Term Trading Opportunities, McGraw-Hill, New York: 2001.

Pring, Martin J. Technician’s Guide to Day and Swing Trading, McGraw-Hill, New York: 2003.