What is swing trading? Learn the strategies beginning traders may use to profit

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Edited by

Brian Beers

Published on March 04, 2022 | 5 min read

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If you’re going to be a stock market trader, you’ll need a trading strategy to guide your decision making. Trading approaches can differ based on a number of factors such as time horizon and the type of analysis involved. One of the most popular approaches is swing trading, which seeks to profit off of price momentum in either direction, meaning there’s the potential for traders to make money in both bull and bear markets.

Here’s what else you should know about swing trading before you get started.

What is swing trading and how does it work?

Swing trading is a short- to medium-term trading strategy that attempts to profit from price swings in a stock or other financial asset. Positions are usually held for a few days up to several months. Traders who use the swing trading method study price charts and use other forms of technical analysis to make their decisions. They may also incorporate some elements of fundamental analysis into their trading.

Once a swing trader has identified a stock that they think is going to move in one direction or another, the trader establishes a position and attempts to profit from the “swing” over the coming days or weeks. Typically, swing traders don’t capture all of the price move in a stock, but rather establish their position after the swing has started and exit before it has ended.

On the long side, traders look to profit as the market or stock swings from oversold to overbought, whereas on the short side, traders hope to ride the swing from optimism to pessimism.

Basic swing trading strategies

Swing traders don’t all take the same approach to selecting securities. Some might rely solely on technical indicators, while others may incorporate fundamental analysis. Here are some of the most common strategies swing traders use.

Support and resistance – Traders looking at support and resistance levels are using one of the foundational elements of technical analysis. Support levels are created at a price where buying interest is strong enough to “support” a stock’s price, whereas resistance levels are where selling pressure overcomes buy orders. Swing traders may look to buy off of the support levels and sell near resistance levels.
Simple moving averages – Traders can use simple moving averages to help identify support and resistance levels or a new bullish or bearish trend. Moving averages are a way to smoothen out a security’s price movements and attempts to eliminate noise from the market. When a short-term moving average moves above a long-term moving average, it may indicate a bullish trend, whereas if it moves below a long-term average, a bearish turn may be starting.
Using fundamental analysis – Though most swing traders rely heavily on technical analysis, it’s important to be aware of things like earnings announcements and economic indicators that can influence a stock or the overall market. Holding a position in a stock going into an earnings announcement could mean that you’re making a bet on the company’s results more than its trading pattern.

Pros and cons of swing trading

Pros

Potential to capture large returns in a short time frame – Swing traders may be able to realize significant profits as a stock moves over a period of weeks or even months. More short-term traders, such as day traders, miss out on these outsized gains by closing their positions each day.
Limit risk through stop-loss orders – You can use stop-loss orders to limit the amount of risk you have from any given position. Stop-loss orders allow you to place a buy or sell order at a specific price, which enables you to pre-determine where to exit a position. Stop-loss orders can be set at any price level and are designed to stop you from losing more in any single trade.
Don’t need to be a pro – Swing trading doesn’t require you to monitor positions every second of the day the way some trading strategies do and the underlying analysis is fairly simple to learn. While you’ll need to check on your portfolio regularly while swing trading, it doesn’t need to be your full-time job, especially if you’re only trading one or two positions at a time.

Cons

Subject to market risk – Because swing traders hold their positions beyond a single day, they’re subject to overall market risk and may suffer when unanticipated events occur. Geopolitical tensions may arise out of nowhere, causing a market sell-off that they didn’t see coming.
Missing the forest for the trees – By seeking to profit off of price swings over a series of days or weeks, swing traders may miss out on the long-term investment returns available through the stock market. Missing out on just a few key days can have a major impact on your investment returns over time.
Short-term capital gains taxes – As with any trading strategy, taxes will be owed on any investment gains. But for short-term capital gains (assets held for less than one year) you’ll be taxed at ordinary income rates. One way to avoid these taxes is to make the trades in a retirement account such as a traditional or Roth IRA.

Swing trading vs. day trading

The main difference between swing trading and day trading is the time horizon involved. Day traders typically close out their positions at the end of each day, leaving them with no exposure overnight. Swing traders, however, will hold positions over multiple days or even across weeks or months.

Both strategies use technical analysis to determine which positions to take, but swing traders need to be more aware of macroeconomic issues and company fundamentals due to the longer holding period. Day traders are also more likely to manage several positions throughout the day, while swing traders might have only a few positions that they track for days or weeks.

Risks of swing trading

As with any form of trading, swing trading comes with the risk of significant losses. These can be mitigated somewhat by using stop-losses, but the risk of loss can’t be eliminated entirely. When you invest for the long-term in a diversified portfolio you have time on your side, but that’s not the case with short-term trading. Anything can happen over a period of days or weeks.

By trading frequently, you’ll also run the risk of having higher costs than you would with a long-term strategy. Though most online brokers don’t charge commissions for stock and exchange-traded fund (ETF) trades these days, there can also be hidden costs of trading such as being out of the market during a large upswing. If you’re trading in a taxable account, you could also generate a large tax bill.

Swing traders are pursuing an active strategy, which means they’re attempting to outperform the overall market through superior analysis. But active strategies tend to underperform a passive approach over the long-term. Passive strategies seek to match the returns of market indices such as the S&P 500 or Russell 2000 and typically come with low costs. Swing traders should be aware that by taking an active approach, they’re fighting an uphill battle.

Bottom line

Swing trading can be a profitable strategy for traders who are adept at using technical analysis, and it has the potential to work in both bull and bear markets. It’s not without risks, however, and you could end up with worse returns than if you pursued a long-term strategy.

If you’re new to swing trading, consider testing your strategy with a small portion of your portfolio first. Very few traders are able to generate attractive returns over the long term.

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Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.