What is swing trading and how does it work?
Swing trading is an investment method that consists of trying to trade a swing that corresponds to the general trend of a market in order to try to improve its performance. Once reserved for the foreign exchange market, swing trading is now used in many markets and has the particularity of using only technical analysis to try to determine the next price movement.
Swing trading is therefore primarily concerned with generating small profits on a regular basis. However, it does not require constant monitoring of the charts as in day trading. In this case, the swing trader will generally analyse the market, take a position and monitor it or place stop orders in order to close it at the right time.
As we will see below in detail, swing trading uses various technical indicators such as Fibonacci lines, MACD, channels and supports and resistances.
What are the strengths and weaknesses of swing trading?
Of course, when properly mastered and used by an experienced trader, swing trading is an investment method that can have certain advantages. However, it is still extremely risky and you must therefore also take into account the risks that such a strategy represents. Let's summarize the advantages and disadvantages of this method.
Some of the benefits of swing trading include:
- Clear limits defined in advance: With the Swing Trading strategy, the trader defines precisely when to take a position as well as the stop-loss and take profit to be placed in order to cut his losses if necessary and take small profits.
- Trading on the trend: Unlike other strategies that involve anticipating trend reversals, swing trading seeks to take positions solely in the direction of the market. It thus exploits the natural flows and movements of the market.
- The ability to cut losses: By placing stop losses with little deviation from the opening price of the position, the Swing Trader generally seeks to limit his potential losses. It is estimated that a swing trading strategy generally shows a profit/loss ratio of 3:1. Of course, this implies that many positions are closed with losses and it is therefore necessary to take this risk into account.
- The multiplication of positions: Finally, the last advantage of swing trading in the eyes of those who use it concerns the possibility of having many positions open at the same time by using all the opportunities of the market in the short and medium term. Although less nervous than day trading, the swing trading strategy tends to hold its positions for only a short time, always trying to stick to the cyclical movement of the market and to trade in the direction of the trend.
Of course, as mentioned earlier, swing trading also has its limitations that you should be aware of. Here are its main flaws and the risks involved:
- First of all, swing trading requires a perfect mastery of technical analysis, which is not given to all investors, and requires a certain experience. Capital losses are also frequent and can be high, which will penalize some investors who have not foreseen this parameter in their strategy.
- The unpredictability of the market is also a disadvantage for this strategy, which is largely based on probabilities. As you probably already know, the market does not always behave in accordance with the data from technical analysis and remains totally unpredictable. It is therefore common for an asset to take the opposite trend to the one expected and thus lead to significant and unanticipated losses.
- Finally, and given that the Swing Trader can keep open positions for several days or even several weeks, he can be confronted with opening gaps. Indeed, it happens that the market opens a session with very large price gaps which can, if this gap goes against the position taken, lead to a sudden and strong loss of capital and cause the closing of a position below the expected stop-loss.
Technical indicators used in swing trading:
As we briefly mentioned above, swing trading is based primarily on technical analysis and the study of various chart indicators. We will now present the indicators most frequently used by investors using this method.
- The MACD indicator : This is the technical indicator most used by swing traders. The MACD shows two lines, a signal line and a line representing the moving average. Technical analysis dictates that the crossing of these two lines is a sign of potential trading. An upward cross is considered a bullish signal and a downward cross is considered a bearish signal. The MACD is also used to determine the volatility of a market.
- Fibonacci lines : This other indicator is often used by investors to identify technical support and resistance levels of an asset. Over time, it has been found that markets tend to fall to certain levels before continuing regardless of their long-term trend. These levels are represented by a percentage of the overall market movement at 61.8%, 23.6%, 38.2% and 50%. Swing traders generally use these levels to determine an entry point, stop loss or take profit level.
- Support and Resistance Levels : Here, another technical and chart indicator most frequently used in swing trading is support and resistance levels. Here, a support level refers to a price level at which buying pressure has been exceeded by selling pressure and can be interpreted as a sign of a change in trend direction. A resistance level, on the other hand, indicates a price level that has already shown selling pressure exceeded buying pressure and is likely to lead to a downtrend. Again, support and resistance levels are often used by swing traders to best determine their market entry points, stop loss and take profit levels. However, the assumption of a price rebound on these levels is not a certainty and it happens that the price of an asset crosses these support and resistance levels without any problem and that the trend does not reverse but continues beyond. Once again, this indicator should be used with great caution.
- Channels : Channel trading is one of the most widely used swing trading strategies on the markets. It consists of speculating only in the direction of the trend by first drawing a channel on an upward or downward trend. Most often, a swing trader will choose to take a position when the asset price touches the bottom of the channel and place his stop loss or take profit on the other side. Of course, since the market is unpredictable, it is often the case that the price does not bounce off these levels or that the trend reversal occurs before they are reached. This explains why the channel strategy also has risks that you should be aware of.
As we have just seen, technical analysis is therefore at the heart of any swing trading strategy. But if fundamental analysis is not really used by investors who use this method, it should not be neglected. Indeed, it happens that an event that affects an asset closely or remotely, such as a news item or an important strategic publication, causes an acceleration or a reversal of the trend, calling technical analysis into question.
What is the difference between Swing Trading and Day Trading?
One of the most common questions asked by investors interested in trading strategies is the difference between swing trading and day trading.
In reality and if these two strategies may seem similar or very close, the main difference between them concerns the time frames analyzed and the time during which a position is kept open. This seems logical since day trading consists of closing all positions before the end of the session, whereas swing trading can keep them open for several days or even weeks. Similarly, the time units used here will be different because they depend on the investment horizon, which in this case is short term for day trading and medium term for swing trading.
There are also other notable differences between Day Trading and Swing Trading strategies. For example, it is known that positions taken through a day trading strategy are often larger than those taken through swing trading.
It should also be noted that the trader who carries out a Day Trading will use both technical analysis and fundamental analysis, while the trader who carries out a Swing Trading will focus primarily on the data of technical analysis.
Finally, the profile of the trader for whom these two methods are intended is also a major point of difference. Indeed, Day Trading requires spending more time in front of the screen and in front of the charts in order to monitor its positions and the evolution of prices. It therefore requires a great deal of reactivity but also great resistance to stress. Swing Trading requires less time and attention but a greater mastery of trading tools such as deferred orders.
Whichever method you choose to use for your investments, you should keep in mind that trading is an activity that presents significant risks to your capital.