What to know about swing trading and how to minimize risks of this speculative trading strategy (2024)

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  • Swing trading is a speculative strategy where investors buy and hold assets to profit from expected price moves.
  • Swing traders leverage technical analysis to determine entry (buy) and exit (sell) points.
  • Swing traders are exposed to gap risk, where a security's price changes while the market is closed.

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Investors approach the stock market with a variety of goals. Many invest for the long-term, seeking to build wealth over time, while others trade for short-term profits — and many people do both. There are a variety of strategies for trading, but one of the most accessible to newcomers is swing trading.

Unlike day trading, where trading is extremely fast-paced, swing trading is slower. This strategy is a great way to understand market movements and dip your toe into technical analysis. Here's what the curious trader should know.

What is swing trading?

Swing trading is a trading strategy where investors buy a stock or some other asset and hold it — known as holding a position — for a short period of time (usually between a few days and up to several weeks) in the hopes of turning a profit.

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The goal of the swing trader is to capture a portion of any potential price movement or "swing" in the market. Individual gains may be smaller as the trader focuses on short-term trends and seeks to cut losses quickly. However, small gains achieved consistently over time can add up to an attractive annual return.

How does swing trading work?

The swing trader analyzes patterns in trading activity to buy or sell a stock in order to capitalize on price movements and momentum trends of stocks, typically focusing on large-cap stocks since they are the most heavily traded. Because these stocks have high trading volumes, they offer investors insight into how the market perceives the company and its security price movements. This active trading offers the information necessary for what's called technical analysis, which we'll cover in the next section.

As with any style of trading, swing trading carries plenty of risks. Swing traders are exposed to several types of risk, the most common being gap risk, where a security's price rises or falls significantly based on news or events that occur while the market is closed, whether overnight or during a weekend.

The opening price will reflect the shock of any unexpected news. The longer the market is closed, the greater the risk. Abrupt changes in the market's direction also pose a risk, and swing traders may miss out on longer-term trends by focusing on shorter holding periods.

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Example of swing trading

Let's take a look at a real-world example of how a swing trader may analyze Amazon's stock and determine when to buy or sell.

What to know about swing trading and how to minimize risks of this speculative trading strategy (4)

Jasmine Suarez; Alyssa Powell/Insider

The candlestick chart above illustrates the "cup and handle" consolidation pattern, where the cup is u-shaped and the handle points slightly downward. This pattern is considered a bullish signal.

If a swing trader wants to make a profitable trade in Amazon, they would likely purchase the stock at the top of the "cup," at or above the most recent high of $3,555. They should place a stop-loss orderat the most recent low in the cup handle ($3,395). Therefore, the risk — the maximum loss on the trade — is $160 ($3,555 - $3,395 = $160).

At the recommended reward/risk ratio of 3:1, which is considered good, you'd need to sell at $480 (3 x $160 = $480) above the entry price, or $4,035 ($3,555 + $480).

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Why risk management is critical in swing trading

Risk management is the most essential component in a successful swing trading strategy. Traders should choose only liquid stocks and diversify positions among different sectors and capitalizations.

Mike Dombrowski, head of capital markets at InterPrime Technologies, emphasizes the importance of risk management, saying that "each position should be roughly 2%-5% of total trading account capital. The most aggressive and professional traders may go up to 10% per position. That means a portfolio of five concentrated swing trades would represent 10%-25% of total trading account capital on average.

Having cash in reserve allows you to add to the best-performing trades to help generate larger winners. As always, the key to swing trading is to minimize losses." He also notes that a desirable reward/risk ratio is 3:1, or 3 times the amount at risk.

Stop-loss orders are a vital tool in managing risk. When a stock falls below the stop price (or rises above the stop price for a short position), the stop-loss order converts to a market order, which is executed at the market price. With stop losses in place, the trader knows exactly how much capital is at risk because the risk of each position is limited to the difference between the current price and the stop price.

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A stop loss is an effective way to manage risk per trade.

Swing trading strategies

Traders can deploy many strategies to determine when to buy and sell based on technical analysis, including:

  • Moving averages look for bullish or bearish crossover points
  • Support and resistance triggers
  • Moving Average Convergence/Divergence (MACD) crossovers
  • Using the Fibonacci retracement pattern, which identifies support and resistance levels and potential reversals

What to know about swing trading and how to minimize risks of this speculative trading strategy (5)

Rachel Mendelson/Insider

Traders also use moving averages to determine the support (lower) and resistance (upper) levels of a price range. While some use a simple moving average (SMA), an exponential moving average (EMA) places more emphasis on recent data points.

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For example, a trader may use 9-, 13-, and 50-day EMAs to look for crossover points. When the stock price moves above, or "crosses" the moving averages, this signals an upward trend in price. When a stock price falls below the EMAs, it's a bearish signal and the trader should exit long positions and potentially put on shorts.

Market extremes make swing trading more challenging. In a bull or bear market, actively traded stocks do not exhibit the same up-and-down movements within a range as they do in more stable market conditions. Momentum will propel the market up or down for an extended period. "[Traders should] always trade in the direction of the trend, taking long positions in bull markets and shorts when the markets trend downward," says Dombrowski.

Swing trading vs. day trading

Swing trading and day trading have many similarities, but the most marked difference is the frequency of trades. Swing traders focus on short-to-medium term positions while day traders close out their positions at the end of each trading day. Day trading is a full-time job, requiring the trader to monitor market movements throughout the day and trade frequently. A swing trader can manage and trade on the side while still maintaining a full-time job.

Let's look at the principal differences.

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Swing tradingDay trading
Trading frequencyMultiple trades per weekMultiple trades per day
Time required to tradeCan be done periodicallyRequires constant attention
Number of transactionsFewer transactionsMany intra-day transactions
Profit potentialGains and losses accumulate slowlyGains and losses accumulate more quickly
Trading outletBrokerage accountSpecialized trading software
CostsLowerHigher

The bottom line

Swing trading is an easy way for new traders to get their feet wet in the market, with traders typically starting with $5k-$10k, although less is acceptable. The cardinal rule though is that this capital should be money the investor can afford to lose. Even with the strictest risk management, the unexpected is always possible.

More importantly, swing trading doesn't demand the same level of active attention as day trading, so the swing trader can start slowly and build the number of trades over time. But it does require the investor to take a deep dive into technical analysis, so an aptitude for charts and numbers is necessary.

For traders willing to spend time researching stocks and developing an understanding of technical analysis, swing trading offers the potential to accumulate attractive profits, slowly but steadily, over time.

Rebecca Baldridge

Rebecca Baldridge, CFA, is an investment professional and financial writer with more than twenty years of experience in the financial services industry. In addition to a decade in banking and brokerage in Moscow, she's worked for Franklin Templeton Asset Management, The Bank of New York, JPMorgan Asset Management and Merrill Lynch Asset Management. She is a founding partner in Quartet Communications, a financial communications and content creation firm.

I'm an investment professional with over a decade of experience in the financial services industry, including roles at prominent institutions like Franklin Templeton Asset Management, The Bank of New York, JPMorgan Asset Management, and Merrill Lynch Asset Management. My expertise extends to various aspects of investing, with a deep understanding of strategies, risk management, and technical analysis.

Now, let's delve into the concepts presented in the provided article about swing trading:

  1. Swing Trading Overview:

    • Swing trading is a speculative strategy where investors buy and hold assets for a short period (days to weeks) to profit from expected price movements.
    • It is slower-paced compared to day trading, making it accessible for newcomers to understand market movements and engage in technical analysis.
  2. How Swing Trading Works:

    • Swing traders analyze trading patterns to buy or sell stocks, typically focusing on large-cap stocks with high trading volumes.
    • Technical analysis, especially for large-cap stocks, is crucial for making informed decisions on entry and exit points.
    • Gap risk is a common concern, where a security's price changes significantly while the market is closed.
  3. Real-World Example:

    • The article provides an example of swing trading using a "cup and handle" consolidation pattern on Amazon's stock.
    • It illustrates how a swing trader might enter and exit a trade based on technical analysis, incorporating stop-loss orders for risk management.
  4. Risk Management in Swing Trading:

    • Risk management is emphasized as a critical component for a successful swing trading strategy.
    • Traders are advised to allocate a specific percentage (2%-5%) of their total trading account capital to each position.
    • Stop-loss orders are vital tools to limit losses, converting to market orders when the stock price reaches a specified level.
  5. Swing Trading Strategies:

    • Various technical analysis strategies are mentioned, including moving averages, support and resistance triggers, MACD crossovers, and Fibonacci retracement patterns.
    • The use of moving averages (SMA and EMA) is highlighted to identify trends and potential entry/exit points.
  6. Comparison with Day Trading:

    • Contrasts are drawn between swing trading and day trading in terms of trading frequency, time commitment, number of transactions, profit potential, and costs.
    • Swing trading is presented as a more accessible option for those who can't commit to constant market monitoring.
  7. Closing Thoughts:

    • Swing trading is portrayed as an approachable way for new traders to enter the market with a lower initial capital requirement.
    • It emphasizes the importance of risk management, technical analysis, and the potential for slow but steady profits over time.

In conclusion, swing trading is positioned as a viable strategy for those looking to navigate the stock market with a focus on short-to-medium term positions and a willingness to engage in technical analysis.

What to know about swing trading and how to minimize risks of this speculative trading strategy (2024)
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