Swing trading is a technique that has general application. Therefore it can be applied to the trading of any financial instrument that experiences price changes on the sale of days, weeks, or months. Swing trading can be discussed in the context of Forex, stocks, or even bonds, but it is not a specific tool geared toward any specific financial asset. Once you understand the basic techniques used with swing trading such as moving averages, then you can apply them to any financial asset you are interested in trading.
Swing trading really isn’t a strategy. In fact, it uses the same strategies used by day traders. Rather it’s simply a time frame or style. So the same strategies are used but they are applied to different time frames. This has significant implications of course. Day traders are actually looking for the same types of price moves, just on different time scales. Since a swing trader is willing to hold their position overnight and out to weeks or even a few months, the risk is significantly lower.
Some of the tools and strategies used by swing traders that are also used by day traders including:
Looking for support and resistance
Looking for chart patterns
Moving averages
Bollinger bands
Trending and counter-trending
Looking for signals in candlesticks
We will be discussing each of these in future chapters.
Forex
Forex is short for foreign exchange, and is a market where people trade one currency against another in pairs. Traders seek to profit from price swings of trading pairs and use a technique called long-term trend following. Swing trading also follows trends, but does so over short time periods, but time periods that exceed those used by day traders. On Forex markets, you can expect to hold positions for more than a day to a few weeks. Forex traders that use swing trading as a technique will study charts over the course of days to look for bring price swings they can take advantage of to earn profits.
Swing traders on Forex are looking for volatility. When there is more volatility, there is a greater chance that prices will have larger swings between high and low values, offering more chances for short term profits. Large price swings as well as more frequent price moves can aid the swing trader.
As a swing trader on Forex, you aren’t going to be as concerned with specific currency pairs in terms of what currencies make up the pair, but whether or not the pair offers the types of price moves you are looking for, that is big swings that offer a solid buy-low and sell-high possibility. Moving averages are frequently used when applying swing trading to Forex. As we will see in a future chapter, using moving averages can help you properly identify coming market trends, and therefore find the right entry and exit points for your trades.
Swing trading is quite different than scalping, so you are not looking to profit from small price movements that occur over very short time periods. Scalping and day trading require a lot of attention to the markets that will have to be focused whenever you hold a position. Because swing trading takes place over longer time frames, constant attention to the markets isn’t necessary. Of course you still have to pay attention, but its something that is far more amenable to part-time attention rather than having to go all in. When using swing trading on Forex, you will want to keep track of economic and political news that has the capacity to roil the markets or cause rallies for one currency over another.
Options
Options are a type of derivative that has an underlying financial asset, such as shares of stock. Most option traders are trading stock options. The option gives the buyer the right to buy or sell shares of stock at a fixed price, which is called the strike price. Options that give the buyer (of the option) the right to buy shares of stock are known as calls. If the option gives the buyer the right to sell shares of stock at the strike price, it’s known as a put.
Option trading is amenable to swing trading because options are timelimited. Every options contract comes with an expiration date. The lifetime of an option can be quite varied, lasting from one week (so-called weekly) to a month, to several weeks, and even one year or more. Options that last one year or more are called LEAPs. However, no matter how long an option lasts, they all operate in basically the same fashion.
Unlike stocks, part of the pricing of an option is determined by “time value”. The closer an option gets to the expiration date, the less time value the option has. That adds an extra wrinkle to trading options that other financial securities don’t have – for example you can hold stocks for however long as you like. For details on how this operates, please download my book on Options Trading.
Since options (generally speaking) have a lifetime that fits well within the time periods that swing traders use, they naturally fit within a swing trading paradigm. A swing trader of options can use the same techniques of analysis that a swing trader of stocks or other financial assets will use to determine price swings. Puts offer an opportunity to short the market, so swing traders interested in shorting can use puts for that purpose rather than having to deal with the complexities and risks of using margin to borrow shares of stock.
Options have many strategies that specialists in options trading use to generate income, but those are not of interest to the swing trader. A swing trader will only be interested in using swings in stock price to profit from trading calls or puts at the right moment in time. This is a simpler approach rather than having to learn all the complicated schemes that have been put together to minimize risk with options. Instead, you will use the same tools to look for signals in the market that a swing trader of stocks is using, and then take advantage of buy and sell signals to buy or sell the appropriate options. The main difference will be focusing on the time value of the options and noting how that can impact pricing.
Stocks
Swing trading obviously has application to the stock market, and we will use it for many of our examples. You can use swing trading to profit from the moves of any stock, but high volatile stocks are going to work better, because you are more likely to see large price swings in the stocks that you decide to take positions in. When using swing trading with stocks, there are different ways to approach it. At any given time a stock may be fluctuating within specific ranges, and you can use this information to get a general idea of what the best share prices are to enter and exit trades. Big news can always cause a massive pricing move, and one thing you will look for are earnings reports. Its also important to study company fundamentals, but with an eye on profits during the current and next quarter rather than viewing them through the lens of a long-term investor. Earnings reports can offer opportunities to profit from swing trades, provided that you are correctly anticipating the way the reports are going to go. Most of the time whether or not a company is actually profitable over the previous quarter isn’t as important as to whether or not they fail to meet, meet, or exceed expectations. Something that you will be interested in doing is seeing what analysts are saying so that you know what the expectations are. Keep in mind that it’s possible to make an incorrect judgment in this case, which can lead to significant losses.
Product news and even political and financial news can have a large influence on stock prices. If the FDA approves a new drug, then that could mean a significant rise in share prices. The introduction of a new smart phone might do the same, but if features were not as exciting as investors hoped, it can leave the stock moving sideways or even crashing low.
While paying attention to news is important, you don’t want to give it the most weight. The fact is you are going to be the last person getting the news, long after institutional investors or large hedge funds have gotten the information. At best, you’ll be getting the news at the same time but they are going to be able to react to it instantly, long before you can.
So most of your focus should be directed at looking at the stock itself, and how its behaved over recent time frames and out to a year. You don’t necessarily want to look back too far, since behavior of the stock five years ago isn’t nearly as relevant as the behavior of the stock in recent months.
Some of the tools used for doing analysis on the stock market are the exact same tools and techniques that would be used on Forex. First and foremost, this will include using candlesticks and recognizing various chart patterns. You will also put a lot of emphasis on using support and resistance.
Simply put, support is a price level below which the stock doesn’t seem to fall past. Of course it can fall below the support level, but if a lot of the data from previous charts suggest a strong support level, that means that its going to take major bad news about the company to cause it to drop significantly below that point. This can be used as an entry point for your trades.
Resistance is the upper price level the stock may be unable to break. Like support, its going to take a major change to get the stock to break above resistance. That major change could take many forms, it might be the introduction of a new product, an unexpectedly positive earnings report, or a change of CEO. Therefore you should spend time following the news related to companies you are trading, but don’t let that be the final word, or obsess over it too much. Just use it as one piece of information in your overall toolkit. To see why, go back to the spring and summer of 2008 and see what all the analysts were saying – most of them were dead wrong. Of course that doesn’t mean they are always wrong, they are often right, but you have to take what they say with a grain of salt. So use your analysis and spot trends, know where the levels of support and resistance are, and then pay attention to special news items or events that could cause a major price change for the stock of the company.