Definition of swing trading
What is swing trading?
Swing trading is a trading method aimed at taking advantage of trend or counter trend movements. An investor will seek to capture some of the bullish or bearish movement to generate profits. Therefore, the ideal swing trade is buying at the lowest and selling at the highest. Of course, this almost never happens, and if it does, it's due to luck. Swing trading uses all the elements of technical analysis (chart patterns, Japanese candlesticks, technical indicators, etc.) to predict the future changes in an asset's price.
Trend Trading vs Counter Trend Trading
Swing trading groups together trend and counter trend trading. In both cases, it is important to know how to identify an asset’s trend and be able to detect trend reversals.
With a trend trading strategy, the swing trader seeks to capture movements in the direction of the trend. The trend may be bullish or bearish.
With a counter trend trading strategy, the swing trader seeks to capture correction movements in a bullish trend and rebounds in a bearish trend.
No strategies are better than others in swing trading. No strategy is perfect, they all have their advantages and disadvantages. Some will perform better in phases of high volatility and others in less volatile phases. Your strategy must be related to your psychology. For example, it is impossible for a trend trader to apply a counter trend strategy over the long term. Effectively, during loss phases that any trading strategy goes through, a trader will question the strategy. He will no longer believe it and will stop applying it.
There are thousands of winning swing trading strategies. The hardest part of trading is not finding a strategy but being able to stick to it over the long term.
Swing trading rules to follow
Money management: Like any trading method, swing trading requires you to follow money management rules. You must therefore use a stop loss on all your positions and deal with reduced leverage. Your risk on one trade should never exceed 2% of your portfolio. If you have several positions at the same time, you can lower the level to 1% or even 0.5%. You should not have too much overall leverage.
By forcing yourself to follow these basic rules, it is impossible to raze your account (even with a bad strategy). Money management allows you to last over time and survive the loss phases of your swing trading strategy.
You must also have a positive risk/return ratio on each trade. This ratio should normally tend towards 2. This means that a winning trade can cover two losing trades if you take an equal risk on each trade. If your price objective is too close to your stop loss, you should not open a position. Swing trading aims to capture, if possible, large trend movements. If you see that the bearish or bullish potential is too low, look for another opportunity. With swing trading, you need to be patient to wait for the right trading opportunities. Do not seek to be constantly in position.
One-way trading: In swing trading, you have to set yourself a direction to trade in. To do this, you must differentiate the signal graph (time unit of your trade) from that of your trend graph (time unit greater than your trade). If you are trading on a daily chart, look at the trend on the weekly chart.
On your trend chart, you need to identify the key levels. There is a level above which you only allow yourself long positions (direction to trade long), another where you only allow yourself short positions (direction to trade short) and a final level where you are asset neutral. So, if you are long on your trend chart, you should not take into account the bearish signals on your signal chart.
Swing trading lets you trade with the trend or the counter trend, but in both cases, it is essential to have a clear bullish/bearish signal on your signal chart. Opening a position is not done by feeling. For example, opening a position on a purchase just because the price is on a support is not advisable. It is better to wait for a price rebound before buying.
Swing trading in practice
Exiting a trade: In swing trading, the exit on a winning trade can be done either on objective, or up until the trend is exhausted. Your trend graph can then be very useful for determining the up/down potential. If you see that it is steep (remote support/resistance, strong currency push on Forex, euphoria/panic on equity markets, bullish/bearish rally, etc.), it could be beneficial to exploit this potential and keep hold of your trade. If not, take your winnings when you reach your objective. Of course, as you trade, you must move your stop loss to protect your winnings. To make the most of your trade and cut at the right time, you must also be able to identify trend reversals.
Risk Management: In swing trading, it is very important to have irreproachable risk management. It is better to have about the same risk on each trade or your account will be too influenced by one trade. If you trade on different time units, it is better not to risk more on a longer term trade. On large time units, you could then reduce the size of your position.
It is important to be able to strictly follow the money management rules of swing trading. Once you deviate from them, it is very difficult to apply them again. That is then the beginning of a vicious cycle that will lead you to losing all your capital.
Finally, it is wise not to exceed a certain level of risk on all your swing trading positions. Risking 1% on each trade is good but if you open 15 positions at the same time, it could be dangerous. It is better to set a maximum loss level for the day. If this level is reached, you should not take any more new positions. For example, you could set yourself a maximum loss equivalent to twice your average daily earnings. So, even on a very bad day (only losing trades), you have the opportunity to catch up on your loss over the following days without being forced to take additional risks. If you set too high a loss amount, you will feel like you can never come back and your emotions will take over. That is the beginning of the end!
Volatility: In swing trading, many traders think volatility is their ally. They tell themselves that it is possible to generate profits more quickly. Volatility is a danger, it increases the risk of seeing your stop loss reached (even if your scenario comes to fruition). You should therefore avoid trading during economic announcements. If you are in position before an announcement, consider spreading your stop losses. It is better no to take a position just before an important announcement (interest rate, unemployment rate, inflation, etc.). Consult the economic calendar to keep yourself informed of the various announcements to come.
Advantages of swing trading
A multitude of trading strategies: There are thousands of winning swing trading strategies. Keep in mind that the complexity of a trading strategy is unrelated to the performance generated. In swing trading, it is better to keep it simple. Using chart patterns, resistances and supports and a technical indicator (e.g. the RSI) to detect discrepancies and bullish/bearish signals is largely sufficient to succeed.
Free time: Unlike scalping, swing trading might not be so time consuming. Once you have opened a position, you no longer need to constantly monitor your trade’s movements. Your stop loss is there to protect you in the event of a reversal.
The more you trade on long time units, the less time you spend trading. Swing trading can be practised by all types of traders, regardless of the time available to them. It is also strongly advisable to take regular breaks, even if you are doing short term swing trading. Trading exacerbates your emotions, the longer you stay in front of the screen, the greater the risk that your emotions will take over.
Low impact of commissions: In swing trading, the price objectives are long term in contrast to scalping. The impact of the spread and the various transaction costs (on the stock market) on trade performance is therefore small. Moreover, with swing trading, the number of trades is reduced.
Winning/losing trades ratio: This is one of the great advantages of swing trading. A winning trade can cover several losing trades. If your risk/return ratio is 2 on average, it means that by winning on only 1/3 of your trades, you are at zero. Even on Forex where 9/10 of traders are losers, a major study showed that traders were winning on average on 50% of their trades. This is more than enough to generate performance if you respect the money management rules.
Disadvantages of swing trading
High stress: Swing trading generates a great deal of stress due to the time the trades are held. On the one hand, price objectives are rarely achieved in a straight line. The price makes more or less marked correction movements. You may then be tempted to cut your trade prematurely. This is why I advise you not to sit in front of your trading screen, especially if you are a novice trader. You need to let your trade breathe if you want to capture big trend movements with swing trading.
Stress is also important because positions can be maintained overnight and over the weekend. That's why you need to manage your risk on every trade. If you don't sleep with a free mind, you are risking too much of your capital.
Irregular earnings: In swing trading, you will alternate between phases of losing and winning. It is sometimes frustrating and annoying to end a trading day in a loss position. Tell yourself that this is part of trading. It is impossible to have only winning trades. If your trading strategy is good, your winning phases will largely cover your losing phases.
Losing phases can last several days, or even spread over an entire month in swing trading. You should not question your trading strategy. This is why novices are advised to always test their trading strategy at length on a demo account. This builds confidence in your strategy to overcome loss phases.
Of course, if you're just losing, there has to be a reason. Analyse each of your losing trades to see if you made a mistake (and in this case correct it in your future trades) or if it is simply the market that gave you the wrong signals. Remember that your scenario can be the best in the world (with a high probability of coming to fruition), in the end, it is always the market that decides.
Difficult psychological management: In swing trading, loss management is complicated. During loss phases, a trader may question his strategy. He could also give in to his emotions when faced with the difficulty of finding the trade that could cover his series of losing trades. It is important that you don’t do this. You have to be able to take trades one by one without thinking about them globally. Be as objective as possible in your decision-making. A position should never be taken under the influence of emotions, you should always wait for a signal from your trading strategy. It is also unwise to increase your leverage to try to cover a series of losing trades. Winning trade series happen too.
Swing trading is a trading method that offers many advantages and is suitable for most traders. There are trading strategies for all types of traders. However, swing trading puts your psychology to the test. It is essential to scrupulously respect the money management rules. Your trading strategy makes you earn money and money management prevents you from losing too much. Unlike scalping, swing trading gives the trader a lot of time to think about his strategy and trades. So you have to be able to manage this pressure and this permanent questioning, hence the importance of having confidence in your strategy (by testing it on a demo account).