The Swing Trader

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

The swing trader - stock chart showing uptrend with entry and initial stop

Chart by

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.

Trailing Stop-Loss

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 swing trader - stock chart showing how the above trade was stopped out with target

Chart by

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 swing trader - stock chart showing stopped out using trailing stop method

Chart by

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

The swing trader - stock chart using SAR parabolic stop and reverse to manage the trade for the investor

Chart by

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.

Swing Trading - picture of a stock chart in an uptrend with candle chart and trend lines shown on a light blue and light green glass background panel

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.

Conditional Orders

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.

Swing Trading - picture of a stock swinging up and down along with the trend with candle bars highlighting trend shown on a dark blue background board

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.

Short Selling

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.