The dirty secret of investing is that the traditional buy and hold portfolio is dead. Well, I’m exaggerating a little, but make no mistake, increased stock market volatility is forcing change.
By including an element of swing trading in their portfolio, investors can evolve their approach to match the new investing world. This evolution can both mitigate increased volatility and accelerate their wealth creation.
The new investing world is notable for increased volatility. This volatility is, in part, caused by algorithms that now dominate the investing space; A small ripple of selling can trigger huge waves of algorithmic selling in response. Look at the speed of the market's collapse at the start of the Covid-19 pandemic as evidence.
Table of Contents
- 1 What is Swing Trading?
- 2 Day Trading Vs. Swing Trading
- 3 The Key Advantages of Swing Trading
- 4 Swing Trading with Candlestick Charts
- 5 Two Simple Swing Trading Strategies That Work
- 6 Conclusion: Mind Your Emotional Intelligence
What is Swing Trading?
Swing trading can go a long way to counter this volatility and add extra juice to investors’ returns.
While long term investing has a timeline measured in months if not years, swing trading has shorter time frames. Swing traders aim to profit from changes in prices over as little as a day to several weeks.
For example, investors concerned about a short-term fall in the stock market can insure themselves using inverse Exchange Traded Funds (ETFs) such as SQQQ. Other investors might look to complement their stock portfolio with exposure to foreign currencies (forex) or commodities.
Some long-term investors might indeed be inclined to steer away from trading. Perhaps they regard it as too risky.
But as I'll explain, it doesn't have to be that way. Remember also, buy and hold portfolios aren't immune to risk. As I've already explained, it's just the opposite.
Swing traders look to profit from relatively short-term price changes in stocks or other financial instruments. They have little use for the kind of fundamental analysis which buy and hold investors use.
Instead, what swing traders do use are price charts.
Within these price charts, traders look for recurring patterns that may give clues about future price direction.
Additionally, they have numerous technical indicators that can guide when to buy and sell. Risk management – the protection of a trader's money becomes a swing trader’s primary focus.
Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.
As the great investor Warren Buffet has said. The key to wealth creation is not to lose money. For swing traders, it is to manage risk in return for the potential for making greater profits. So, for every $1 risked, they might aim to make at least $3.
How many buy and hold investors do you know who can define the point at which the investment's original premise is no longer true?
I bet not many
When combined with highly disciplined risk management, swing trading can become less risky than any buy and hold type investment.
- Swing traders primarily use price charts, while investors tend to use fundamentals.
- Swing trading focuses on profiting from short term changes in the price.
- The risk/reward ratio of a swing trade is calculated before a trade.
Day Trading Vs. Swing Trading
While you still might struggle with the concept of swing trading, you may be more familiar with day trading.
As the term suggests, day traders look to profit immediately from very short-term moves in the price during the day. So they will open and close trades during the day and will seldom keep a position longer.
These traders will buy and sell multiple times, and as a consequence, they plan trade entries and exits using price charts in minimal time periods.
Typically, day traders will use 1 hour, 30 minutes, 15 minutes, 5 minutes, 1-minute, or even ‘tick' price charts. Each point on the chart represents an hour's (or whichever period) worth of trading activity. With tick charts, each price point is a single incremental change in price.
As you can imagine, the shorter the timeframe, the more ‘busy' the price chart looks. Consequently, it can be hard to see through the market’s randomness to find sustainable and tradable price changes.
Day traders will rely almost exclusively on technical indicators and have little concern with the fundamental factors driving price over longer time-frames.
Conversely, swing traders, while also primarily using technicals, will take their risk home overnight. In other words, they hold positions for days, sometimes, multiple weeks.
Such traders aim to profit from a single, strong price change in the market (swings). They will generally plan their trades using the daily charts. Although shorter time-frames such as the 4 or 1 hour, or even lower, may help calculate entries with more accuracy.
Day trading for a living?
I'm arguing the case for swing trading as part of a larger buy and hold portfolio. I'm not here to suggest quitting your job to take up day trading.
I did exactly this; I traded futures on commodities and currencies for a period, so I speak with some authority on the subject.
I know that day traders need to spend considerable time at their trading computers each day from my own experience. That's not the case when swing trading.
Day trading didn’t suit my temperament. At times, I found it very intensive and very exhausting; I wouldn't recommend it. However, if your emotional make-up is right and you're super motivated, don't let me stop you.
Profitable day trading relies on fast and accurate technical analysis. Beginner traders need to realize they're competing against algorithms that do whatever they do but in milliseconds.
On the other hand, swing trading, done the right way, can be stress-free. Plus, swing traders can ignore the daily financial news cycle that is part of the “noise.”
The Key Advantages of Swing Trading
If you are working a full or even part-time job, then it's likely that swing trading could be a good fit for what limited time you have.
Trading decisions can be made once per day, perhaps at the end of the day, with orders to enter new trades emailed to your broker for the next day. Remember, you’re risking a defined amount in the expectation of making a multiple more. However, you don’t know in advance which one of your swing trades will be profitable.
So, when you’re in the trade, what’s the best thing you can do? Absolutely nothing, there’s nothing you can do. Let go of the need to monitor what the market is doing. The trade will either work or not. You’re free to carry on with your day job or whatever else you’ve got going on.
Another advantage of swing trading is that it can introduce the trader to trading on margin.
The concept of margin trading might be new to investors, but it's common to swing traders and day traders.
Margin trading allows the trader to borrow funds from their broker (in return for paying interest). Thus, trading on margin means the trader can commit less capital to any one trade idea.
Capital use can become much more efficient. An investor might allocate a small portion of his capital to swing trading, say, less than 10%. With this 10% allocation, he can both target protecting his long term, buy and hold portfolio while also capturing price changes. There’s strong evidence this diversification of strategies and markets should improve his overall returns.
Trading in this way also allows you to pay attention to the economic and political news events that may be about to impact the price of stocks, currencies, or commodities.
Remember that the principles and strategies of swing trading set out below can be applied to all markets, not just stocks but also forex and commodities.
Swing Trading with Candlestick Charts
This is a term you will hear all the time as you learn about trading. But there's no mystery to it. All it means is how supply and demand are reflected in the changing price of the instruments we want to trade.
Fortunately, we have at our disposal one of the most straightforward but most ingenious analytical tools ever invented – the candlestick chart.
First devised in the 17th century by Japanese rice traders. The candlestick is simply a visual image that gives, at a glance, five crucial pieces of information about any instrument.
The candle's body will tell us the opening and closing levels, and the candle's color will tell us whether the price increased or decreased during any given period.
Above and below the candle body, the wicks (or shadows) will tell us the high, and low prices reached during the same period.
So, once you know what to look for, even a single candlestick can provide you with a wealth of information.
That said, better value is found in understanding the recurring patterns that successive candlesticks typically form.
Thorough knowledge of these patterns is the foundation of success. They will tell you whether the price is trapped in a horizontal range or trending strongly in one direction or another.
They will notify you when the price is likely to stall or reverse (at areas of support or resistance) and the best places to enter and exit your trades.
Two Simple Swing Trading Strategies That Work
That said, numerous technical indicators can help us interpret and act upon what the candlesticks are telling us. These are simple to use on today's trading platforms.
Additionally, simple swing trading strategies can make highly profitable use of both candlesticks and indicators. Below, I outline a couple of common strategies. If you want to go into more depth, check out this post.
The Moving Average Trend Trading Strategy
Moving averages are simply an average of an instrument's closing prices over a given number of periods. Moving averages are plotted as lines on the price charts.
That said, Exponential Moving Averages (EMAs) are far more useful. These averages give greater importance to the most recent price changes.
What's interesting is that traders often use these EMAs as areas to buy or sell. So for swing traders, EMAs become places to enter or exit trades. EMAs are so widely used they almost become self-fulfilling.
So when entering a trend, it's always best to wait for a pullback and pause in price. Often, this consolidation brings price close to the EMA before the trend resumes.
A small body candle close to an EMA offers a low-risk entry where price frequently tends to hug the EMA as it trends up or down.
The example below shows a typical bull trend trade.
This kind of trade is widespread and illustrates why “the trend is your friend” is one of the best-known sayings in trading.
It's a straightforward entry that led to a 7-day move and healthy profit.
When exiting the trade, we can take profits when we hit a pre-determined target – ideally, three times the amount we're risking.
If we want to extract the maximum profit, we can let the trade run its course.
We need to know, though, that when the price gets too far away from the EMA, it's highly likely to pull back, as happened in this case.
Nevertheless, we could still have exited safely and profitably when the first red candle closed below the EMA.
These kinds of trades frequently occur in strongly trending markets, and they're an excellent way for beginners to get started. Unfortunately, though, markets are often chopping sideways, with price trapped in a horizontal range rather than trending.
If we are to maximize our profit, we need to have another strategy in our toolbox. We need a strategy that allows us to trade when the price is frequently reversing.
The Double Top or Bottom
Double top or bottom patterns can indicate potential price reversals. These happen when trends are losing momentum or price is caught in a range.
This is one of the simplest swing trading strategies. Both double top and double bottom partners occur when price tries and fails in two attempts to break a level of resistance (double top) or support (double bottom).
With intervening candles forming, double tops often show a pattern resembling a letter M, double bottoms a W.
However, these patterns are rarely, if ever, perfect.
Tops and bottoms will not always be at precisely the same price levels. So support and resistance lines may not be exactly horizontal. And it may be that several small consolidation candles occur between the tops and bottoms.
What's important is not finding perfect geometrical patterns but identifying clear areas of support and resistance that price has reacted to on at least two occasions.
Here's an example showing a double top and bottom that could both have led to profitable swing trades.
Conclusion: Mind Your Emotional Intelligence
I’ve laid out above two basic swing trading strategies. There are many strategies available; you must test which works best for you. All are capable of accelerating your wealth creation.
However, far more important than any particular strategy is your mental approach to the market and your emotional self-control. Of course, don’t forget risk management.
No matter how much technical knowledge you acquire, you will not succeed at trading unless you can manage your emotions.
As a swing trader, you need to have the patience to wait for days or perhaps even weeks for the right trade.
Perhaps above all, you need to be able to accept with equanimity the losses that even the best traders inevitably suffer. You can do this by learning from the experience and waiting patiently for the next opportunity just around the corner.