Swing Trading Explained
What Is Swing Trading?
Swing trading is a type of stock market trading that attempts to capitalize on short-term price momentum in the market. The swings can be to the upside or to the downside, and typically occur within a range from a couple of days to a couple of weeks. While day traders typically stay invested in a position for minutes or hours, swing traders invest for several days or weeks. Still, swing trading is a more short-term strategy than investors who buy and hold onto stock for many months or years. But it’s important to bear in mind the potential risks, costs, and tax implications of this strategy.
Generally, a swing trader uses a mix of technical and fundamental analysis tools to identify short- and mid-term trends in the market. They can go both long and short in market positions, and use stocks, exchange-traded funds, and other market instruments that exhibit pricing volatility.
It is possible for a swing trader to hold a position for longer than a few weeks, though a position held for a month or more may actually be classified as trend trading.
Cost and Tax Implications
A swing trading strategy is somewhere in between a day-trading strategy and trend-trading strategy. They have some methods in common but may also differ in some ways — so it’s important to know exactly which you plan to utilize, especially because these shorter-term strategies have different cost and tax factors to consider.
Frequent trades typically generate higher trading fees than buy-and-hold strategies, as well as higher taxes. Unless you qualify as a full-time trader, your short-term gains can be taxed as income, rather than the more favorable capital gains rate (which kicks in when you hold a security for at least a year).
How Swing Trading Works
Swing trading can be a fairly involved process, utilizing all sorts of analysis and tools to try and gauge where the market is heading. But for simplicity’s sake, you may want to think of it as a method to capture short-to-medium term movements on share prices.
Investors are, in effect, trying to capture the “swing” in prices up or down. It avoids some day trading risks, but allows investors to take a more active hand in the markets than a buy-and-hold strategy.
With that in mind, swing trading basically works like this: An investor buys some stock, anticipating that its price will appreciate over a three-week period. The stock’s value does go up, and after three weeks, the investor sells their shares, generating a profit.
Conversely, an investor may want to take a short position on a stock, betting that the price will fall.
Either way there are no guarantees, and swing trading can be risky if the stocks the investor holds move in the opposite direction.
Day Trading vs Swing Trading
Like day traders, swing traders are highly interested in the volatility of the market, and hope to capitalize on the movements of different securities.
Along with day traders and trend traders, swing traders are active investors who tend to analyze volatility charts and price trends to predict what a stock’s price is most likely to do next. This is using technical analysis to research stocks–a process that can seem complicated, but is essentially trying to see if price charts can give clues on future direction.
The goal, then, is to identify patterns with meaning and accurately extrapolate this information for the future.
The strategy of a day trader and a swing trader may start to diverge in the attention they pay to a stock’s underlying fundamentals — the overall health of the company behind the stock.
Day traders aren’t particularly interested in whether a company stock is a “good” or “bad” investment — they are simply looking for short-term price volatility. But because swing traders spend more time in the market, they may also consider the general trajectory of a company’s growth.
Pros and Cons of Swing Trading
|
Pros and Cons of Swing Trading |
|
|---|---|
| Pros | Cons |
| Less time intensive | Expenses & taxes |
| Income potential | Time |
| May help to avoid market dips | Efficacy |
Pros of Swing Trading
To understand the benefits of swing trading, it helps to understand the benefits of long-term investing — which may actually be the more suitable strategy for some investors.
The idea behind set-it-and-forget-it, buy-and-hold strategies is quite simply that stock markets tend to move up over long periods of time, or have a positive average annual return. Also, unlike trading, it is not zero-sum, meaning that all participants can potentially profit by simply remaining invested for the maximum amount of time possible.
1. Time and Effort
Further, long-term investing may require less time and effort. Dips in the market can provide the opportunity to buy in, but methodical and regular investing is generally regarded higher than any version of attempting to short-term time the market.
Swing trading exists on the other end of the time-and-effort continuum, although it generally requires much less effort and attention than day trading. Whereas day traders must keep a minute-by-minute watch on the market throughout the trading days, swing trading does not require that the investor’s eyes be glued to the screen.
Nonetheless, swing trading requires a more consistent time commitment than buy-and-hold strategies.
2. Income
Compared to long-term investing, swing trading may create more opportunity for an investor to actively generate income.
Most long-term investors intend to keep their money invested — including profits — for as long as possible. Swing traders are using the short-term swings in the market to generate profit that could be used as income, and they tend to be more comfortable with the risks this strategy typically entails.
3. Avoidance of Dips
Finally, it may be possible for swing traders to avoid some downside. Long-term investors remain invested through all market scenarios, which includes downturns or bear markets. Because swing traders are participating in the market only when they see opportunity, it may be possible to avoid the biggest dips. That said, markets are highly unpredictable, so it’s also possible to get caught in a sudden downturn.
Cons of Swing Trading
Though there is certainly the potential to generate a profit via swing trading, there’s also a substantial risk of losing money — and even going into debt.
As with any investment strategy, risk and reward are intrinsically related. For as much potential as there is to earn a rate of return, there is potential to lose money.
Therefore it is smart to be completely aware of — and comfortable with the risks, no matter which investing strategy you decide to use.
1. Expenses & Taxes
A good rule of thumb: Don’t trade (or invest) money that you can’t afford to lose.
Additionally, it can be quite expensive to swing trade, as noted above. Although brokerage or stock broker commissions won’t be quite as high as they would be for day traders, they can be substantial.
Also, because the gains on swing trades are typically short-term (less than a year), swing investors have to keep an eye on their tax bill as well.
In order to profit, traders will need to out-earn what they are spending to engage in swing trading strategies. That requires being right more often than not, and doing so at a margin that outpaces any losses.
2. Time
Swing trading might not be as time-consuming or as stressful as day trading, but it can certainly be both. Many swing traders are researching and trading every day, if not many times a day. What can start as a hobby can easily morph into another job, so keep the time commitment in mind.
3. Efficacy
Within the investing community, there is significant debate as to whether the stock market can be timed on any sort of regular or consistent basis.
In the short term, stock prices do not necessarily move on fundamental factors that can be researched. Predicting future price moves is nothing more than just that: trying to predict the future. Short of having a crystal ball, this is supremely difficult, if not impossible, to do.
Swing Trading Example
Here’s a relatively simple example of a swing trade in action.
An investor finds a stock or other security that they think will go up in value in the coming days or weeks. Let’s say they’ve done a fair bit of analysis on the stock that’s led them to conclude that a price increase is likely.
Going Long
The investor opens up a position by purchasing 100 shares of the stock at a price of $10 per share. Obviously, the investor is assuming some risk that the price will go down, not up, and that they could lose money.
But after two weeks, the stock’s value has gone up $2, and they decide to close their position and sell the 100 shares. They’ve capitalized on the “swing” in value, and turned a $200 profit.
Of course, the trade may not pan out in the way the investor had hoped. For example:
• The stock could rise by $0.50 instead of $2, which might not offer the investor the profit she or he was looking for.
• The stock could lose value, and the investor is faced with the choice of selling at a loss or holding onto the stock to see if it regains its value (which entails more risk exposure).
Going Short
Swing traders can also take advantage of price drops and short a stock that they think is overvalued. They borrow 100 shares of stock from their brokerage and sell the shares for $10 per share for a total of $1,000 (plus any applicable brokerage fees).
If their prediction is correct, and the price falls to $9 per share, the investor can buy back 100 shares at $9 per share for $900, return the borrowed shares, and pocket the leftover $100 as profit ($1,000 – $900 = $100).
If they’re wrong, the investor misses the mark, and the price rises to $11 per share. Now the investor has to buy back 100 shares for $11 per share for a total of $1,100, for a loss of $100 ($1,000 – $1,100 = -$100).
Swing Trading Strategies
Each investor will want to research their own preferred swing trading strategy, as there is not one single method. It might help to designate a specific set of rules.
Channel Trading
One such strategy is channel trading. Channel traders assume that each stock is going to trade within a certain range of volatility, called a channel.
In addition to accounting for the ups and downs of short-term volatility, channels tend to move in a general trajectory. Channels can trend in flat, ascending, or descending directions, or a combination of these directions.
When picking stocks for a swing trading strategy using channels, you might buy a stock at the lower range of its price channel, called the support level. This is considered an opportune time to buy.
When a stock is trading at higher prices within the channel, called the resistance level, swing traders tend to believe that it is a good time to sell or short a stock.
MACD
Another method used by swing traders is moving average convergence/divergence, or “MACD.” The MACD indicator looks to identify momentum by subtracting a 26-period exponential moving average from the 12-period EMA.
Traders are seeking a shift in acceleration that may indicate that it is time to make a move.
Other Strategies
This is not a complete list of the types of technical analysis that traders may integrate into their strategies.
Additionally, traders may look at fundamental indicators such as SEC filings and special announcements, or watch industry trends, regulation, etc., that may affect the price of a stock. Trading around earnings season may also present an opportunity to capitalize on a swing in value.
Similarly, they may watch the news or reap information from online sources to get a sense of general investor sentiment. Traders can use multiple swing trading methods simultaneously or independently from one another.
Swing Trading vs Day Trading
Traders or investors may be weighing whether they should learn swing trading versus day trading. Although the two may have some similarities, day trading is much more fast-paced, with trades occurring within minutes or hours to take advantage of very fast movements in the market.
Swing trading, conversely, gives investors a bit more time to take everything in, think about their next moves, and make a decision. It’s a middle-ground between day trading and a longer-term investing strategy. It allows investors to get into some active investing strategies, but doesn’t require them to monitor the markets minute by minute to make sure they don’t lose money.
Swing Trading vs Long-Term Investing
Long-term investing is likely the strategy that involves the least amount of risk. Investors are basically betting that the market, over the long term, will be higher several years from now, which is typically true, barring any large-scale downturns. But it doesn’t give investors the opportunity to really trade based on market fluctuations.
Swing trading does, albeit not as much as day trading. If you want to get a taste for trading, and put some analysis tools and different strategies to work, then it may be worth it to learn swing trading.
Is Swing Trading Right for You?
Whether swing trading is a good or wise investing strategy for any individual will come down to the individual’s goals and preferences. It’s good to think about a few key things: How much you’re willing to risk by investing, how much time you have to invest, and how much risk you’re actually able to handle on a psychological or emotional level — your risk tolerance.
If your risk tolerance is relatively low, swing trading may not be right for you, and you may want to stick with a longer-term strategy. Similarly, if you don’t have much to invest, you may be better off buying and holding, effectively lowering how much you’re putting at risk.
Active Investing With SoFi
Swing traders invest for days or weeks, and then exit their positions in an effort to generate a quick profit from a security’s short-term price movements. That differentiates them from day traders or long-term investors, who may be working on different timelines to likewise reap market rewards.
Swing trading has its pros and cons, too, but can be a way for investors to try out trading strategies at a slower pace than a day trader.
There are also different methods and strategies that swing traders can use. There is no one surefire method, but it might be best to find a strategy and stick with it if they want to give swing trading an honest try. Be aware, though, that it carries some serious risks — like all stock trading.
The SoFi Invest® stock trading app offers educational content as well as access to financial planners. The Active Investing platform lets investors choose from an array of stocks and ETFs. For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. Please see terms and conditions here.
FAQ
Is swing trading actually profitable?
Swing trading can be profitable, but there is no guarantee that it will be. Like day trading or any other type of investing, swing trading involves risk, though it can generate a profit for some traders.
Is swing trading good for beginners?
Many financial professionals would likely steer beginning investors to a buy-and-hold strategy, given the risks associated with swing or day trading. However, investors looking to feel out day trading may opt for swing trading first, as they’ll likely use similar tools or strategies, albeit at a slower pace.
How much do swing traders make?
It’s possible that the average swing trader doesn’t make any money at all, and instead, loses money. That said, some swing traders can make thousands of dollars. It depends on their skill level, experience, market conditions, and a bit of luck.
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