Introduction to Swing Trading (2024)

Swing Trading - What is Swing Trading?

A quick Internet search will yield many potential definitions of swing trading. However, most all fail to approach it from a technical analysis perspective.

The typical definition is that it is a style of trading that carries a position overnight. This position is also held up to several weeks.

This definition lumps all trades that aren’t held overnight as day trades. It also lumps all trades of more than a few weeks a position or trend trade.

This may be enough for a fundamental trader. One who doesn’t have the tools to differentiate a style of trading apart from a holding period.

But it comes up short for those looking to apply technical analysis principles.

One of the most important principles of technical analysis is that it is “fractal” in nature.

That means technical analysis principles like trend, support and resistance, etc. These can be applied to a daily chart. They can also be applied to charts of various aggregation periods such as intraday, weekly or monthly.

A swing trading system based on technical analysis could be applied to any aggregation period length you choose.

This understanding separates the concept of swing trading from a holding period and transforms it into a style of trading.

In this Intro you’ll learn about swing trading as a style based on the cyclical nature of price movement.

You'll also learn the role of trend, indicators and risk management methods that would be used when swing trading.

Swing Trading - Price Cycles

Market prices move in cycles as the price moves from troughs to peaks and then back to troughs.

This cycle is continuously repeated. Price moves generally in an upward, downward or sideways direction or trend.

The peaks and troughs that form on the chart are referred to as highs and lows. In Figure 1, you’ll see a 6-month daily price chart for the S&P 500 Index (SPX) with its cyclical highs and lows.

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Figure 1—Highs and Lows on a Daily Chart of the SPX

A swing trade is therefore playing the move or “swing” from the low to high or high to low. In technical analysis terms these are referred to as “swing highs” and “swing lows.”

This type of pattern exists for intraday charts as well as weekly and monthly charts.

In Figure 2, you’ll see a 5-day, 15-minute chart of the SPX. In Figure 3, you’ll see a weekly chart of the SPX with its highs and lows identified.

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Figure 2—Highs and Lows on a 15-Minute Chart of the SPX

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Figure 3—Highs and Lows on a Weekly Chart of the SPX

You must know the specific aggregation period of each chart. Otherwise, you can't tell which one was intraday, daily or weekly.

Even the number of periods between highs and lows are relatively similar for the different aggregation periods.

There are always some nuances that differentiates trading different aggregation periods. The length of the cycles between highs and lows of the various aggregation periods is significant. These average holding periods will be similar.

A swing trade on an intraday, daily or weekly chart will be held for a similar number of periods.

Regardless of aggregation period, a swing trading system can be developed. A system to capitalize on the moves from swing lows to swing highs.

Swing Trading - The Role of Trend

Trend is defined by the progression of the of the highs and lows on the price chart.

For example, an uptrend is when the price is forming sequentially higher highs and lows. A downtrend is when the price is forming sequentially lower highs and lower lows.

In Figure 4, you’ll see a 1-year chart of Ford Motor Company (F). This demonstrates periods where it was in an uptrend, downtrend and sideways trend.

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Figure 4—Daily Chart showing Trends of Ford Motor Company

The significance of trend in a swing trading system isn’t as pronounced as in other types of systems.

It’s not about the trend of the price as much as the degree of movement between highs and lows.

Swing traders might find opportunity trading a defined range between highs and lows in a sideways trend. As much opportunity as they would trading upward swings within an uptrend.

Many swing traders will trade in the direction of the trend when trading daily or weekly aggregation periods.

Countertrend swing trading systems are more unusual when trading daily and weekly aggregation periods. The exception is in cases where the price has moved to a relative extreme.

However, for intraday swing traders the trend may not be as significant. Order flow tends to move price.

This causes trends to change more frequently and experience more frequent extreme moves as the aggregation period is shortened.

Regardless of whether you’re trading in the direction of the trend, it's important to know the trend of the price.

Swing Trading vs. Trend Trading

Looking at some charts, you might question why someone wouldn’t just hold through minor corrections in the price and just play the trend over a longer period of time.

Playing the trend is limited as to the amount of money that can be made on a particular move. By increasing the frequency of trading, it provides the trader with the potential for increased profits that can be made on that trend.

The intent of a bullish swing trade is to sell at the swing high. Then buy back in at a lower price than it was sold in order to play the swing back up to the next swing high.

Swing trading trends with longer cycles between highs and lows is an approach that should outperform a trend trade.

However, in periods where the cycle between highs and lows is relatively short, with shallow corrections, it’s likely the swing trader will underperform the trend trader.

Swing Trading - Indicators

Often times traders will use indicators as a means of representing the movement that is happening on the chart.

Indicators use algorithms based on the price data for open, high, low, and close in order to identify trend, support and resistance.

Some indicators will incorporate volume as a means of gauging the internal strength of a trend.

Swing Trading - Trending Indicators

Moving averages are a common indicator used when determining the trend of the price.

While it’s possible to identify trend by the progression of its highs a lows, many traders prefer moving averages as a way to simplify things or to make their system less discretionary.

Simple and exponential moving averages tend to be the most popular types of moving averages that most traders use.

A simple moving average places equal weight to each closing price over the look-back period selected, whereas exponential moving averages provide greater weight to the most recent price movement.

Typical settings for moving averages that represent the trend of highs and lows range from 20-50 periods.

In Figure 5, you’ll see the same daily chart of Ford Motor Company (F), but with a 30-day simple moving average (red) applied to it.

You may notice that the price generally follows the direction of the trend outlined in Figure 4.

When the price is uptrending, the moving average is rising, and the price is trading above it.

When the price is downtrending, the moving average is falling, and the price is trading below it.

In sideways trends, the price is moving back and forth through the moving average and the moving average is relatively flat.

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Figure 5— Daily Chart of Ford Motor Company with a 30-day Simple Moving Average

A swing trader that is engaged in a trend-following system would only take swing trades that are moving in the direction of the trend.

In other words, if the moving average is rising and the price is trading above it, a bullish swing trade would be taken as the price finds support at its swing low.

A bearish swing trade would be taken as the price finds resistance at the swing high when the moving average is falling, and the price is trading below the moving average.

Swing Trading - Oscillating Indicators

Oscillating indicators are used to help confirm areas of support and resistance or highs and lows.

They get their name because the indicator oscillates back and forth with the price as it moves through its cycle.

Some indicators are bound within a range and many of them incorporate some form of moving average of the price within them.

Common indicators that traders use are the MACD, RSI, Stochastics, CCI and many others.

When applying an oscillators, they typically have a default setting for the number of lookback periods.

Based on a typical 4-week cycle of the daily price chart, most oscillators will have a default setting that ranges from two to 14 days (one-half of the number of calendar days in a 4 week cycle).

Depending on how early you want the signal to occur, the period length will be lengthened or shortened accordingly.

The shorter the period length, the faster and more frequent the signals will occur.

Figure 6 below is a daily chart of Ford Motor Company (F) with a Full Stochastic and a (5,5,5) setting.

As the fast line (%K) crosses above the slow line (%D) it is an indication of support and a possible signal to enter a swing trade.

As the %K (red) line falls below the %D (purple) line it is an indication to close a swing trade position.

In this example, only long positions are taken as the 30-day moving average is rising and the entry is based on a trend-following swing trading system.

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Figure 6— Daily Chart of Ford Motor Company with the Full Stochastics Indicator (5,5,5)

Swing Trading - Risk Management

When swing trading, profits and losses are realized quickly as the price loses momentum.

Because winners are smaller when compared to systems that have longer holding periods, it’s important to consider the risk and reward of a potential trade.

Stop-loss orders are commonly used as a means of controlling risk. A stop order is a preset order that will close your position at market if the stop price is triggered.

Stop limits can also be used but may fail to sell the stock or option if the price falls too quickly or gaps below your stop price.

The stop is triggered, but the limit order isn’t filled since the desired price is outside the market price.

A mental stop could be employed. However this does require discipline to follow your system’s rules and manage the risk.

Average True Range (ATR) is an indicator that is commonly used as a means of determining how far below the entry price (long positions) or above the entry price (short positions) your stop should be.

The ATR is calculated by averaging out the range between the high and low or the previous day’s close to the next day’s high or low, whichever’s greater.

A typical period setting for the ATR is 14 periods, which equals one-half of the 4-week cycle for a daily chart.

A stop of 1-2 times the ATR is typically used as a stop for swing trading, and that rule can be applied to intraday, daily or weekly aggregation periods.

Swing Trading - Once the risk is determined, the potential reward can be determined.

If you identify a consistent pattern to how the price is trading, you could measure the amplitude of the cycle as the price moves from low to high for bullish trends or from high to low for bearish trends.

In sideways trends, the range between the highs and lows can easily be measured to calculate an expected move.

Another application of ATR that can be used as a means of defining projected move is using a monthly ATR when trading the daily chart.

The 14-month ATR would provide an estimate of the range of the price from its low to its high over a complete cycle.

The foundation for this type of method assumes a 4-week cycle for a stock’s price.

The target, based on the monthly ATR value, would then be added to the most recent swing low for a bullish trade or subtracted from the most recent swing high for a bearish trade.

The potential reward would then be the difference between the entry price and the projected target.

Because of the nature of swing trading, it’s important to look for some threshold for reward-to-risk when taking a trade.

Based on your experience with a system, you should have some understanding of the likelihood of a profitable outcome, and the reward-to-risk that is needed to make the system profitable.

It’s common for traders to look for a reward to risk of 2-to-1 before a swing trade is taken. That means for every dollar that is risked, there would need to be at least two dollars of projected profit.

Swing Trading - Conclusion

Swing trading is a popular system of trading and has the potential to increase profitability over a buy and hold approach to investing.

As always, the increased frequency of trading can introduce the potential for greater loss if a systematic approach isn’t used for trading and proper risk management.

It’s important to remember that swing trading isn’t defined by the amount of time in the trade. It’s a style of trading where the price is traded from cyclical lows to highs, or vice versa. It can be applied to intraday, daily, weekly or monthly aggregation periods.

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As a seasoned financial expert with a deep understanding of swing trading and technical analysis, let's delve into the key concepts outlined in the provided article.

Swing Trading Overview: Swing trading is a style of trading that involves holding positions overnight or for several weeks. Unlike conventional definitions, which categorize trades based on holding periods, a technical analysis perspective emphasizes the fractal nature of price movement. This means that technical analysis principles, such as trend, support, and resistance, can be applied across different time frames, making swing trading a versatile style.

Price Cycles: Market prices exhibit cyclical movements, transitioning from troughs to peaks and back. These cycles can manifest in various time frames, such as intraday, daily, weekly, or monthly. The highs and lows in these cycles, known as swing highs and swing lows, form the basis for swing trading strategies.

The Role of Trend: Trend analysis is crucial in swing trading, but it differs from traditional trend trading. While identifying trends involves sequential higher highs and lows in an uptrend and lower highs and lows in a downtrend, swing traders focus on the degree of movement between highs and lows. Trading within defined ranges in a sideways trend is also common in swing trading.

Indicators in Swing Trading: Swing traders use indicators to analyze price movements. Moving averages, both simple and exponential, are popular for determining trends. Oscillating indicators like MACD, RSI, and Stochastics help confirm support, resistance, highs, and lows. These indicators, relying on algorithms and historical price data, aid traders in decision-making.

Risk Management in Swing Trading: Due to the rapid realization of profits and losses in swing trading, effective risk management is essential. Stop-loss orders, based on factors like the Average True Range (ATR), are commonly employed. ATR, calculated by averaging price ranges over a specified period, helps determine the distance for stop orders. Traders typically seek a reward-to-risk ratio of 2-to-1, emphasizing the importance of proper risk management.

Conclusion: Swing trading, characterized by its focus on cyclical price movements, presents a flexible and potentially profitable trading style. The ability to apply swing trading principles across various time frames adds to its versatility. However, the frequency of trading in this approach necessitates a systematic strategy and disciplined risk management to mitigate potential losses.

In summary, swing trading offers a nuanced perspective on trading, incorporating technical analysis principles and adapting to different time frames for a comprehensive approach to navigating financial markets.

Introduction to Swing Trading (2024)


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