Swing Trading

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Swing Trading

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Day trading and intra-day trading focus intentionally on very short entry-to-exit timeframes.

Traders use charts of very small time spans and may take profits within a matter of moments. In comparison, swing trading uses many of the same short-term trend and reversal signals but involves a holding period of at least three days, and in most applications, not more than five days.

Swing traders rely on specific set-up signals for both entry and exit. Because swing traders are playing the swing of price, the current trend’s exit set-up may also serve as the next swing’s entry set-up.

There are four important price patterns for swing trading.

These are:

  1. Three or more short-term trending days. A ‘trend’ is a very specific manner under the rules of swing trading. An uptrend is a series of consecutive sessions characterized by each session showing a higher high price than the previous session, and also showing a higher low price. These higher highs and higher lows must occur at least over three sessions. For example, a three-day series consists of high-low prices of $24-22, $27-23, and $28-25. This is an uptrend because over the three sessions both the high and low levels increased.
    downtrend is recognized as a series of three or more consecutive sessions characterized by lower highs and lower lows.
    For example, a three-day series consists of high-low prices of $24-22, $23-20, and $21-19. This is a downtrend because over the three sessions both the high and low levels decreased.
  2. An NRD. The narrow range day (NRD) is one with a trading range with opening and closing prices close to one another. The NRD may be relative to preceding sessions; but the closer the opening and closing prices, the stronger the indication is that a reversal is coming. It indicates that at the end of the trend, the current price is close to an agreement between buyers and sellers, or that the trending action has been exhausted.
  3. Exceptionally high volume. When a volume spike occurs, it also signals a high chance for a price reversal. The spike occurs for a good reason and may signal that the direction of the existing trend has come to an end, with the other side (buyers versus sellers, or sellers versus buyers) about to take control.
  4. A change in price direction, ending the trend. When a reversal day appears, it clearly ends the trend as defined by swing traders. So a series of upward-moving days concludes with a downward-moving day or vice versa. This, especially when combined with other reversal signals, is a sign of a broader reversal.

When two or more of these signals occur together, they confirm one another and provide the strongest possible indication that the price is likely to stop moving in the established direction and will probably turn and move in the opposite direction.

Key Point

As valuable as reversal signals are that swing traders use, when two or more show up together, the strength of the confirmation is very strong.

The philosophy behind swing trading is based on two observations. First is the basic contrarian strategy. This is the belief that the majority is more often wrong than right. So when prices begin moving upward, a growing number of people buy, with most buyers at the top of the short-term trend. And when prices begin moving downward, a growing number of people sell, with most sellers at the bottom of the short-term trend.

Second is the belief that market decisions are made based on two primary emotions: greed and fear. As prices rise, new buyers come in to get a piece of the action and existing owners of stock do not take profits, because they do not want to miss out on even higher gains. When prices fall, current owners of stock panic and sell, mostly at the bottom of the price swing.

The swing traders acknowledge the strength of greed and fear as motivating forces in the market, but they resist acting in response. They make decisions rationally and without emotion. When greed drives prices up, swing traders look for signs that the trend is slowing or coming to an end. When that happens, they sell long positions or open short positions. When prices are falling, swing traders wait for signals that the trend is bottoming out. At that point, they buy to close any short positions or open long positions.

This swing is normally going to last between three and five sessions. Swing traders want to move in and out of positions that quickly, because part of the strategy recognizes that the short-term emotional reaction is always exaggerated; but it also corrects at the end of that three- to five-day period. In fact, it is the emotional reaction and overreaction that creates the short-term swing.