What is swing trading? All you need to know

You're likely acquainted with investing and perhaps even day trading. But have you explored swing trading?

Swing traders engage in buying and selling financial assets, such as stocks, at a faster pace than long-term investors but slower than day traders. Their typical strategy involves holding positions for several days to several weeks to capitalize on price "swings" — interim highs and lows within a broader trend.

Here, we delve into the distinctions between swing trading, day trading, and long-term investing, along with key factors to contemplate before delving into swing trading.

Strategies for swing trading

Swing traders frequently employ statistical indicators such as moving averages and support or resistance levels to guide their decisions on when to buy or sell stocks.

Moving average crossings

A moving average represents the average price of a stock over a specific period. For instance, a stock's five-day moving average reflects its average price over the past five days, while its 10-day moving average represents its average price over the past 10 days.

Moving averages can be visually represented as lines on a stock chart, alongside the stock's actual price. Swing traders often interpret intersections between these lines as signals to initiate buy or sell actions.

For instance, if a swing trader holds a stock whose price previously remained above its five-day moving average line, and then the price line crosses below the moving average line, the swing trader might perceive this as an indication that the stock's momentum is waning, prompting them to sell it.

Support and resistance level breaks

At times, when a stock is ascending, it frequently approaches a specific price level and encounters resistance before retracting, indicating a struggle to surpass that price level. This upper barrier on a stock's price is termed a resistance level by traders.

Conversely, when stocks decline or exhibit erratic fluctuations, they often repeatedly drop to a certain price level before rebounding, suggesting that this price level serves as a support. Traders refer to this lower boundary as a support level.

Similar to moving averages, swing traders often utilize breakthroughs or breaches in support or resistance levels as signals to buy or sell. For instance, if a stock's price previously fluctuated below a particular resistance level and then surpassed or "broke" that resistance level, a swing trader might interpret this as a signal to purchase the stock.

Should you consider swing trading?

Before delving into swing trading, it's crucial to evaluate your financial circumstances.

Are you meeting your financial obligations, saving money, and investing a portion of those savings in low-cost index funds to plan for retirement and other financial objectives?

Do you have disposable income after addressing the above requirements — funds you can afford to lose?

If your response to all of these inquiries is affirmative, then you may proceed with swing trading using the funds you can afford to lose.

However, if you answered negatively to any of these questions, swing trading may not be suitable for you at this time. It's worth noting that most traders incur losses in their initial months of trading, and many never achieve profitability.

In contrast, the S&P 500 index has historically delivered an average annual return of approximately 10% since 1926. Whether you're a novice or an experienced trader, if you're invested in index funds or ETFs tracking this index, your returns will remain consistent.

Comparing swing trading, day trading, and long-term investing

As highlighted earlier, swing trading occupies a middle ground between day trading and long-term investing. However, in conceptual terms, it shares more similarities with day trading.

Both day traders and swing traders aim for short-term gains through the application of technical analysis. The primary difference lies in the duration of their trades. Day trading involves holding positions for less than a full trading day, sometimes just for a few minutes, while swing trading typically spans multiple days or even weeks.

Moreover, the methodology employed in swing trading slightly diverges from that of day trading. Swing traders analyze long-term trends to identify positions and then aim to capitalize on intermediate highs and lows within those trends. In contrast, day traders focus on exploiting small intraday market fluctuations, largely disregarding long-term trends.

Due to variations in holding periods, swing traders typically execute fewer trades compared to day traders but target higher profits from each trade.

On the other hand, long-term investors pursue gains over years or decades. They rely on fundamental analysis to evaluate a company's future growth potential, dividend payouts, or prospects for recovery, and typically adopt a buy-and-hold strategy until they decide to sell.