Free Investor Education : What is Swing Trading?

What is Swing Trading?

Simply put, swing trading is a short-term strategy that traders use to capitalize on the price “swings” of stocks, usually over the period of a few days. It works because individual investors are able to better capitalize on the short term movements of securities better than trading institutions can. This is because most investment companies do their trading in large quantities that are too big and slow to keep up with swing trading. This principle of squeezing out the big players allows traders to have an even playing field - whereas they would normally be outclassed by superior capital, manpower and experience.

The best companies to swing trade have extremely high trade volume. When we say volume, we mean the amount of stocks that change hands each day. Swing traders focus on these stocks because their prices fluctuate, even if by a small amount, nearly constantly. Also, because there are always people buying and selling, they will have no problem filling orders. High volume stocks are whales - the biggest companies on Wall Street. These companies are well known around the world. Some examples are tech giants like Apple, Microsoft, Facebook and Google. Referred to as “large cap” stocks, these titans have a market capitalization of at least $10 billion. The tech companies that were just listed all have caps of over $200 billion. So what is Market Cap? Take the number of total shares and multiply it by the share price.

In swing trading, investing essentials like intrinsic value and company assets go out the window. The only thing a swing trader cares about are trends and patterns. In order to predict and analyze these patterns, swing traders use what’s called a swing chart. These charts are used to filter out the noise - all the random trading - and identify what is likely to happen based on statistical analysis. There’s a little bit of luck in there too, sometimes you just have to feel it out.

Strategies employed by swing traders

Momentum Trading

A stock is said to have momentum when the stock price starts to move in one direction and is accompanied by a high amount of trading volume. This strategy requires the trader to jump on board soon after the momentum starts and then ride the wave for a while. Careful though, stay too long and momentum could swing in the opposite direction, but jump too soon and you could miss out on potential profit. A happy medium is to set a desired profit and stop there, think of the children.

Fundamental Trading

The crux of fundamental trading is analysis. Fundamentals are the building blocks of a business and their stock price can be related to its activities. The analysis comes in when a trader examines the expected effect of changes like stock splits, acquisitions and earnings reports. While good news might be assumed to be met with a rise in stock price, you never quite know how the market will react to any news - use caution. Fundamental trading is similar to regular trading, but taking place in an extremely short time frame.

Scalping

These traders aren’t selling their stocks last minute outside the arena. Instead, they are in it for the small gain. A scalper will make hundreds of trades a day, but only make a small gain each time. This strategy is effective because of what’s called the bid-ask spread. Essentially, there is a small difference between the highest price one is willing to pay and the lowest price for which a seller is willing to sell it. It’s kind of like a middle man strategy. It takes some finesse to be a scalper, but unlike the ticket scalpers you find trying to make a quick buck, stock market scalpers can make a lot of money.

Swing Trading Systems

Swing trading is not for everyone. Unlike traditional stock picking, swing traders dedicate a lot of their time to making profits in the short term. For many people, it's their job.

Professional scrutiny has lead swing traders towards a more systematic approach. Swing trading systems mainly take the form of stock charts. These charts help the pros identify what’s going on in the marketplace in a statistically significant way. Patterns like support or resistance show that a stock is not likely to keep moving past a certain maximum or minimum price. These boundaries are not the same for all stocks, but are determined by factors like the stock’s historical performance and overall market trends.

Predicting stock prices based on past trends is no simple task. If it was, everyone could make a killing on the stock market. We know that’s not the case but why? It turns out that human behaviour can be strange sometimes and when people jump on the bandwagon stocks can go way up or down due to herd behaviour. At the end of the day, investing in stocks is risky and the prospect of losing your shirt keeps most people honest.

Swing Trading Indicators

Actions sometimes have unintended consequences. You never really know for sure what started a chain of events, because you can always jump back one more link in that chain. It’s a perpetual chicken-egg situation. These unintended consequences are generally NOT what swing traders use to model their strategies. For example, when the events of 9/11 transpired, something strange happened to a product you wouldn’t expect. Pajama sales skyrocketed after 9/11 because people were less willing to go outside. 

This effect is better known as cocooning.

The indicators that swing traders use to make trades often have to do with statistical data. Swing traders use charts to plot this data in a way that they can predict certain trends. One of the most important indicators is volume. Volume refers to the number of individual shares being traded over a specific period. For swing traders, that period is usually a day. 

When volume increases, it is a signal to investors that there is suddenly more excitement about a stock. The price may not move right away, but the excitement is not for nothing - eventually the price will either rise or fall sharply. This technique is called on-balance volume, or OBV for short. It is an essential tool for any swing trader to learn.