Swing trading is a short-term trading style which seeks to capture a short-term move. The classic swing trade as portrayed by the financial press involves trading the rallies in a stock that is in an uptrend.
While there are numerous variations to swing trading, the classic swing trade is by far the most popular version which is also traded on the short side with a stock that is in a downtrend. Some swing traders will short sell the pullbacks in an uptrend which means they are trading against the trend and is known as contra-trend trading.
Classic swing trading works best with trending stocks which are displaying the characteristic sequence of rallies and pullbacks (which are the short-term trends within an intermediate-term trend). The premise here is that the next rally should emerge which is what the swing trader seeks to capture.
Swing trading concepts can be applied to any time frame such intraday, daily, weekly or even monthly. The most common time frames used are daily and intraday since these are very good at highlighting the short-term trends. The daily bars are used by end-of-day traders seeking the short-term stock rallies and the 5 minute bars are used by day traders to capture the intraday swings during the current day. Intraday swing traders are similar to day traders except they continue to hold their positions beyond the current day. These intraday swing trades seek to capture the multi-day swings.
The use of candlestick charting is extremely popular with swing traders as this charting style is very good at highlighting short-term trend reversals.
The classic swing trade is the most popular version of swing trading which uses daily bars and capitalizes on the old saying "The trend is your friend". For a long sided trade, the swing trader locates a stock that is in an intermediate-term uptrend and waits for the stock to pullback. Once this pullback appears to be completed, the swing trader enters their position.
An example of a typical swing trade using daily bars is shown below in Chart 1.
Chart 1. Typical Swing Trade
For a long side trade, the common entry trigger with a pullback is when the stock trades above the high of the previous day (which is the Hammer Reversal candle in Chart 1).
The entry can be taken intraday using a Market buy order with a price trigger. The price trigger is set slightly above the previous day (Hammer Reversal in Chart 1) and when the stock trades above this price the Market buy order is filled.
Alternatively, the trader can wait until the end of the day and place a buy order for the following day.
The initial stop-loss is generally set just below the lowest low of the pullback. Swing traders will frequently use a trailing stop-loss to exit their trade. Another common exit strategy is to place a limit sell order at the profit target.
Some swing traders utilize a trailing stop-loss in conjunction with the profit target. The idea here is that should the stock appear to reverse direction before reaching the profit target, then at least some of the move is locked in as a profit. Common methods of raising the stop-loss level are:
Common methods of raising the stop-loss level:
- Low of the previous day: With this method, the stop-loss level is raised to the low of the previous day whenever the previous days low makes a new higher low. This trailing stop-loss method works well with strongly moving swings, but tends to prematurely stop out the swing trader when the stock does not trade up immediately.
- Low of the second previous day: This method is similar to the above method except that instead of the previous days low, the next days low is used. The advantage with using the second low is that it gives the stock more room to move before being stopped out. The downside is that it hands back more of the open profit if the stock does not reach its profit target.
- Parabolic SAR: This method uses the chart indicator to determine the trailing stop-loss level. The parabolic SAR variables can be set so that it closely follows the price movements and is quite an effective trailing stop-loss tool to use. The results are similar to the second low method above.
The Low of the previous day stop method for the Align Technology, Inc. trade example in Chart 1. is shown below in Chart 2.
Chart 2. Low of the previous day stop method
The Low of the second previous day stop method for the Align Technology, Inc. trade example in Chart 1. is shown below in Chart 3.
Chart 3. Low of the 2nd previous day stop method
The Parabolic SAR stop method for the Align Technology, Inc. trade example in Chart 1. is shown below in Chart 4.
Chart 4. Parabolic SAR stop method
Some swing traders simply use the initial stop-loss and a profit target with no trailing stop-loss. The position is exited at whichever price level is reached first. The advantage with not using a trailing stop-loss is that all the profitable trades yield the maximum available profit. The downside is that there are trades that almost reach the profit target but then reverse and subsequently trigger the initial stop-loss thus resulting in a loss instead of at least a small profit.
The use of a trailing stop-loss in conjunction with a profit target is a personal choice amongst swing traders.
Not all swing traders use a profit target. Instead they use a trailing stop-loss method and ride the swing as far as it will trade before being stopped out. The obvious advantage with not using a profit target is that some short-term trends can move a considerable distance in a short amount of time and using a trailing stop-loss without a profit target allows the swing trader to capture a large portion of this move. The problem is that a lot of stocks only make a moderate short-term move before correcting and then resuming the trend with the next short-term move. The idea behind the profit target is to capture the typical short-term move.
Intraday Swing Trading
Some swing traders seek the intraday swings which last for two or three days and use intraday charts showing several days of data. The time frames these intraday swing traders use typically range from 15 minute bars to 60 minute bars. These intraday swing traders are after the intraday swings which usually run into the next trading day or two. Unlike day traders who exit their positions on the same day, the intraday swing trader will hold their positions beyond the current day until the profit target of their swing is reached or until their trailing stop-loss is triggered. The tactics used by intraday swing traders are basically identical to that of the daily bar swing trader.
Intraday swing traders will typically monitor the market throughout the trading day for their entries and when an entry is signaled they will place their entry order straight away. Some daily swing traders also monitor the market throughout the day just like the intraday swing traders except that they are seeking the short-term trend rather than an intraday move. Even though they are end-of-day traders they monitor the market so as to provide them with a more optimum entry and exit price.
A lot of swing traders do not monitor the markets throughout the day. Instead they place various conditional orders with their brokers for the stocks that show the greatest likelihood that they will trigger an entry during the trading day.
With the popularity of the internet, brokers can easily
provide traders with a variety of conditional orders
These conditional orders are day only orders with the most common type being a variation of a stop-loss order. When this order type is used in reverse it is known as a Stop-Reverse order. For a long side trade, the trigger price is set just above the high of the previous day. Should the stock trade above this trigger price, a market buy order is placed and the swing trader has a open position. If the stock does not trade above the trigger price during the trading day, the stop-entry order is not filled and is automatically canceled by the broker at the end of the trading day.
Some stock brokers allow a 'if filled' order grouping. This means that an initial stop-loss order can be attached to the stop-entry order. If the stop-entry order is triggered and filled, the stop-loss order is then made active.
The swing trader has a choice with how their stop-loss is treated if breached. If a stop-loss order is placed with their stock broker, a market sell order is placed when the stock's price drops below the trigger price of the stop-loss order (assuming a long side trade). Thus the position can be exited at any time throughout the trading day.
Some swing traders prefer to only exit their position if the stock actually closes below their stop-loss level. In this case the swing trader does not place a market stop-loss order, but instead monitors the closing prices. For a long position, when the stock closes below the stop-loss level, the position is exited the next trading day. Some swing traders place a market open order but this can give poor fill prices due to the large Bid-Ask spreads at the market open. Swing traders tend to favor placing their orders with a time delay (good after order) so that the order is executed after the open. The time delay varies but half an hour to one hour after the market opens is fairly common.
These automated order types are convenient for swing traders who are unable to monitor the market during the trading day due to their employment obligations.
Other Swing Trading Styles
Some swing traders use support and resistance levels to locate their swing trades. For a long side trade they look for a stock that has pulled back to a support level and place their buy order at that support level with the initial stop-loss placed below the support level. The advantage of entering a trade at a support level is that it increases the amount of the move since the swing trader does not need to wait for the stock to rebound. The disadvantage is that it tends to decrease the number of winning trades. This is a tradeoff with entering a position early.
Momentum swing trading is a style of swing trading which seeks a quick high powered move. These can come from stocks that are in steep uptrends or from stocks that breakout of a resistance level. Momentum swing traders are merely pickier with the stocks they are willing to trade. While trading high momentum stocks has its advantages, namely the good profits from the winning trades, unfortunately they are vulnerable to a sharp correction which increases the risks.
Swing trading on the short side is essentially the inverse of trading on the long side. The first consideration is that the swing trader requires a trading account which allows short selling. The risks are higher with swing trading on the short side, but not dramatically higher.
Swing trading in general is a moderate risk trading strategy providing that all losing positions are exited at their stop-loss levels. Swing trading becomes high risk when losing positions are not exited and instead held onto.
An additional risk swing trading has is that of the overnight gap. While an overnight gap down with a long position will create significant damage to the swing trader's account, the same gap down with a short position will give their account a significant boost. Fortunately large overnight gaps are fairly rare but they do occur and when they do they are mostly the result of earnings announcements and pre-earnings release warnings.
Trading momentum can be very rewarding, but care needs to be taken
Momentum can cause some confusion with beginner stock traders since the term momentum is used in several different contexts. The term momentum means to move strongly and forcefully. When applied to stock trading momentum refers to the stock price moving strongly in one direction. Since there are numerous time durations for trends, such as the short-term trend, the intermediate-term trend and the long-term trend, momentum can be observed in either of these trends.
Also momentum is a term used with chart indicators and a lot of indicators are referred to as momentum indicators. When the term momentum is used with chart indictors it is referring to rate of increase of a trend. In other words, with indicator terminology the steeper the trend is the more momentum it is said to have. This is because a characteristic of steep trends is a strong price move in one direction.
The reference to momentum is made to both the short-term trend and the intermediate-term trend. For the purpose of swing trading, since swing trading involves the short-term trend, the reference to momentum is to the short-term trend.
Short-term trends more typically include daily bars which overlap each other and there are numerous minor one or two day pullbacks. That is - the short-term trend is usually not a smooth progression, but rather it is a bumpy ride.
A lot of short-term swings display a large amount of days that trade below the low of the previous day which leads to low momentum (not much strength or gain).
With a momentum move the lows and highs of the bars typically progressively increase in a short-term uptrend. A straight trend-line can generally be drawn under the daily lows and the trend-line will connect most of the daily lows. Sometimes a strong momentum move will move upwards with a parabolic trend (the daily lows shown an upwards sloping curve).
Chart 1.below illustrates the difference between a low momentum move and a high momentum move.
Chart 1. Comparison of Low and High momentum moves
Chart 1. above shows two short-term moves. The move highlighted in Green is a high momentum move since the stock moved up strongly with most days making a higher low (and the move gained 22% in 12 days). The other short-term move highlighted in Red is a low momentum move since the stock traded below the previous day's low numerous times (while it gained 18% it took 32 days). The second shoirt-term move highlighted in Green is much stronger than the first move highlighted in Red.
The low momentum moves usually take much longer than the high momentum moves. That is - there are usually more days in a low momentum move than there are days in a high momentum move.
A lot of charts display shorter moves than that displayed in Chart 1. - both low momentum and high momentum.
A chart example with shorter momentum moves is shown below in Chart 2.
Chart 2. Comparison of Low and High momentum moves
The high momentum move is highlighted in Green and the stock moves up strongly (and gains 7% in 8 days). The low momentum move is highlighted in Red and the stock trades below the previous day's lows several times (while it gained 6% it took 13 days). The second short-term move highlighted in Green is much stronger than the first move highlighted in Red.
A momentum move is not necessarily the same as a swing. Swings are the short-term trends that make up an intermediate-term trend. The term Momentum is usually only used in reference to a high momentum move which is a strong short-term directional move.
A high momentum move can occur within a swing as part of that swing. That is - a high momentum move does not necessarily occupy the entire swing move.
A swing can contain both a low momentum move and a high momentum move. This is illustrated below in Chart 3.
Chart 3. Swing with a Low and a High momentum move
Chart 3. above shows a Swing from RL (Relative Low) up to RH (Relative High). This swing started with a high momentum move and finished with a low momentum move.
Sometimes a swing and a momentum move will be the same thing. For example, the rally after a pullback that trades straight up and has every daily bar making a higher low as shown in Chart 2.
A typical swing contains numerous days that trade below the previous day's low (low momentum move). The high momentum moves tend to occur less frequently but a strong market can still produce a lot of high momentum moves.
Classic Swing Trading
With classic swing trading, the entries are normally taken when the stock is already swinging. In other words the stock is in an intermediate-term uptrend and an entry is taken after the stock completes its pullback. Therefore there were at least two prior swings, the preceding short-term uptrend (rally) and the subsequent short-term downtrend (pullback).
A variation to swing trading is loosely referred to as momentum trading. This trading style seeks out the momentum driven moves rather than the typical swings (which are characterized by having a large portion of overlapping days).
With momentum trading, entries are frequently taken at support and resistance levels. Alternatively, entries are also taken with stocks that have had a prior momentum move and paused.
A popular momentum trading tactic is to buy the breakout from a resistance level as these often provide a quick momentum driven rally off from the resistance level. Chart patterns such as an ascending triangle which formed over a month or more also provide a good resistance level for a stock to breakout from. Momentum trading frequently uses the low of the previous day as the stop-loss since a momentum move is expected to make higher lows until the end of the strong move. A low that is below the prior day's low is an indication that the momentum driven move may have topped out.
Trading breakouts is a popular momentum
strategy with swing traders
Some momentum moves actually pause for several days before continuing with a second momentum move. Some momentum traders will buy the break from the pause for the second momentum move. This tactic is more risky than the first move, but the second momentum move when it occurs is usually just as powerful as the first.
Another momentum trading tactic is to buy at a support level which has formed over a month or more. Support levels where the stock has rallied off from and sold back to several tines before are good support levels for momentum driven swings. Stocks can rally hard off a support level and these attract the attention of swing traders who utilize momentum tactics.
These momentum trading tactics are also used with short selling. The downward momentum driven moves are quite often very strong and brief. The breakout on the downside through a support level is a common entry for short sellers. Some momentum traders will short sell at a resistance level with the expectation that the stock will rebound and be sold off again.
Creating the Swing Trading List
How to find good swing trading candidates
Swing traders create a trading list which is a short list of stocks they can track daily for a swing trade entry. This short list includes stocks that are of particular interest to the swing trader and also have a good chance of providing an entry within the next couple of days. Tracking the entire market on a daily basis involves too much work and is also not necessary. The swing trader can readily reduce the number of stocks on the market to include only those that satisfy their trading style.
There are numerous approaches that can be used to create a trading list of stocks. Since swing trading is relatively short-term, the approach used needs to allow the trading list to be constantly refreshed with new swing trading opportunities.
The trading list should be fairly small as this makes it easier to thoroughly analysis each stock. As a guide, swing traders generally have somewhere between 20 to 50 stocks in their trading list. The number of suitable swing trading candidates is dependant on market conditions and the short list may be considerably smaller if market conditions are not conducive to swing trading. Generally trending markets favor swing trading tactics and congested markets are not favorable.
Some swing traders feel that they need a large list since they do not want to miss any opportunities. This is a misguided belief since the whole point of a short list is to reduce the number of candidates to a manageable level so a through analysis of each stock can be preformed. Also if the swing trader attempts to analyze too many stocks at once, their entry choices will in all likelihood be poor choices and they will probably just end up with losing trades. A few good trades that make a profit are better than a lot of trades that lose money.
One of the simplest methods of reducing the number of stocks available on the stock market is to run a scan. Most charting software packages have a scanning facility. These can be web based or off-line. Also some stock brokers also have a scanning facility. Whichever is used does not make any difference as the main point is to reduce the number of stocks by filtering out those stocks that have characteristics which are not desirable.
Generally swing traders prefer stocks that are actively traded through out the day which makes it easier for their entry and exit orders to be filled. A simple filter to use is to scan for stocks which have an average daily volume greater than a minimum limit. The average volume can be over the last 20 days or more. The minimum is a personal choice but as a guide stocks with 1,000,000 shares are very liquid, stocks with 500,000 are fairly liquid, stocks with 200,000 are becoming quite illiquid and below 100,000 are generally very illiquid. Swing traders will generally prefer a minimum average volume of 500,000 or maybe 200,000 shares.
Some swing traders have a preference for a particular market capitalization. They may prefer large-caps or have a preference for small-caps. It is simple enough to run the scan to only include market caps that are desirable.
The two main exchanges are the NYSE and NASDAQ. Some swing traders have a preference for NYSE stocks while others have a preference for NASDAQ stocks. The swing trader can easily filter the scan to only include their preferred market.
Swing traders can also filter the scans to only include industry groups which are performing strongly for long side trades and performing poorly for short side trades. The swing trader can also incorporate the industry Leaders and Laggards concept. Typically the leader in the industry group makes its move first and the smaller stocks will probably follow the leader in whichever direction the leader moves. This provides the swing trader with an additional conformation if the swing from the minor stock is in the same direction as what the leader is already moving in.
The short interest in a stock is another useful concept some swing traders use to filter the stocks on their trading list. The idea behind this concept is that stocks with a high short interest have an additional source of buying pressure when the stock rallies from a pullback.
The list is now reduced but is still way too large. Depending on the trading strategy, swing traders generally prefer swing trading stocks in the direction of the general trend. In other words, a long side swing trade in an up trending stock. The simplest way to scan for up trending stocks is to use a technical indicator such as moving averages.
Swing traders usually prefer to trade
in the direction of the trend
An indicator that is good at detecting up trending stocks involves using two simple moving averages. The scan will include the 20 MA being greater than the 50 MA and the last close being above both the 20 MA and 50 MA. If the scan allows it, the 50 MA being greater than the 50 MA of one day ago, which ensures that the 50 MA is sloping upwards which it must for an up trending stock.
The ADX is another trend following indicator that does a good job of locating trending stocks and is favored by some swing traders. As a general rule, stocks with an ADX above 25 are usually in a strong trend. By using the +DM and -DM the swing trader can filter their scan to include only up trending or down trending stocks. The ADX scan can be used in conjunction with the moving averages.
Depending on how bullish the market is, this list is now considerably reduced but is still too large to track each day.
Further filtering from here is largely dependant on the swing trading style.
The classic swing trade seeks up trending stocks that have pulled back on the daily chart and an entry is taken if the stock trades above the prior day's high. Stocks that are pulling back on a daily chart can be detected with a scan such as for the last 3 or 4 days the high is less than the previous day's high for the last 3 or 4 days. This will reduce the list of stocks considerably.
The next step is to visually examine the daily charts for each stock in this reduced list. The daily candlestick chart is a favorite with swing traders. Some stock charts will display daily trading behavior that is not desirable. For example, the chart may show a lot of gap days (gap up one day, then gap down the next and so on) which generally makes swing trading difficult as the entry may be a significant distance above the prior day's high.
The swing trader should also check the volume bars to see if the average is suitable. Some stocks will have one extremely high volume day relative to the normal daily volume. This artificially boosts the average volume. For example, a stock may have an average volume of 500,000 shares but on examining the volume bars, there was one day with 1,000,000 shares and the rest tend to be around 100,000 shares. Therefore the typical average daily volume is only around 100,000 and the swing trader may well exclude such a stock from the list.
By visually examining the daily chart for each stock, the swing trader can pick the stocks that show the most promise for a swing trade and exclude those that don't.
The list by now should be fairly small. If it is still too large to manage then the swing trader needs to make a decision on how to further reduce the list. The quickest and easiest way to do this is increase the minimum volume requirement. If a 500,000 average daily volume was used, then increase this to say 1.000,000 and exclude stocks from the short list with volume less than this and see how many stocks are left. There is a bit of trial and error here, but the main thing is to have a manageable list size.
While there are other considerations swing traders can use to produce a trading list, the methods discussed include the basic tactics used by most swing traders to produce their trading list.