Swing trading is one of the most popular disciplines applied to the financial markets. It is a short-term approach to the buying and selling of securities with the goal of achieving sustained profitability. Typically, a holding period of two to five days for open positions is implemented in the markets of futures, options, currencies and equities.
Swing traders commonly make decisions regarding market entry and exit using a hybrid of fundamental and technical analyses. Through the application of assorted technical tools within the context of current market fundamentals, practitioners of a swing trading approach look to capitalise upon moves in price over the course of several sessions.
Trading Types: Time Horizons And Duration
The length of time a position is to remain active within the marketplace is a critical component of a trade's makeup and indicative of the adopted methodology. A trade's "duration," or "time horizon," dictates precisely how long it will have to either realise a profit or sustain a loss. Of the many factors that influence the success or failure of an individual trade, duration is one that is truly customisable.
As a general rule, the longer a position remains open, the greater the probability of sustaining a significant gain or loss. As durations increase, exposure to the impact of unexpected news events, trending market conditions or broader systemic risks become important considerations.
Five prominent types of trading activities are clearly defined through active management of the time quotient. They are as follows:
- Investing: Investing is one of the most traditional methods of reaching long-term financial goals. It is the process of acquiring securities with the objective of realising capital appreciation over a substantial period of time. Perhaps the most common investment strategy is known simply as "buy and hold." An example of "buy and hold" is the purchase of corporate stock, mutual funds, real estate or government bonds with the intent to hold the security for years or decades. Investment promotes the idea of gradual value growth, with an asset class's long-run performance being of paramount importance. Diversification, fundamental analysis and patience are key aspects of investing.
- Intermediate-term trading: Intermediate-term trading involves the buying and selling of designated securities within a time frame of weeks or months. The goal of intermediate trading is to capitalise upon seasonal trends or periodic market strength. Patience, as well as strategic flexibility, are important parts of trading successfully in the intermediate-term. Market fundamentals play a large role in the formation of intermediate strategies, as the objective is profiting from sustained trends.
- Swing trading: As stated earlier, swing trading strategies are typically a hybrid of fundamental and technical analysis coupled with trade duration of two to five days. In contrast to investing and intermediate-term activities, swing trading aspires to realise gains through capitalising upon short-term strength or weakness in market behaviour. Due to the condensed time horizon governing market entry and exit, precise timing and attention to pricing volatilities is required.
- Day trading: Day trading is the practice of entering and exiting a market frequently on an intraday basis. Day traders do not hold positions into the overnight period, electing to go home "flat" at each session's close. As a result, many of the risks assumed by the swing and intermediate approaches are avoided. Day trades are conducted with durations ranging from minutes to hours, with the ideology behind trade execution being heavily reliant upon technical analysis.
- Scalping: At its core, scalping is a form of day trading. However, the time horizons involved in trade execution are denominated in milliseconds and seconds instead of minutes and hours. The goal of a scalping strategy is to sustain profitability by taking small gains as soon as they become available. In the current digital marketplace, scalping is a common practice, and one that is highly competitive. Advances in technology have given rise to disciplines such as high-frequency trading (HFT). Many HFT operations are capable of executing trades in microseconds (one-millionth of one second).
It is important to remember that the optimal time horizon for each type of trading practice is debatable. Exact timelines for a successful investment, swing or scalping may vary depending on myriad factors led by general market conditions and the instrument being traded. However, the goal of each discipline is very much the same: achieve profitability.
Trading Types: Advantages And Disadvantages
The five trading methods have several unique advantages and disadvantages. Listed below are a few of the key pros and cons of each:
- Pros: Large profit potential, limited time needed for management, avoidance of risk attributable to periodic market volatility
- Cons: No flexibility, often illiquid, sustained drawdowns possible
- Pros: Potential for big gains from strong trends, minimal trade management required
- Cons: Large fluctuations between P&L, "whipsaw" markets often lead to large drawdowns
- Pros: Strategic flexibility, tighter risk management, ability to capitalise upon current market price and participation
- Cons: Greater time allocation needed to manage trades, inability to "ride out" periods of adverse pricing volatility
- Pros: No overnight risk assumed, limited swings in an individual trade's P&L
- Cons: Physically and mentally demanding, extensive time required
- Pros: Small systemic risk exposure, ultra-tight capital risk controls
- Cons: Extremely competitive, slippage and assorted latencies greatly impact P&L
In many ways, the swing trading philosophy serves as the bridge between the disciplines of trading and investing. While greater capital gains may be available through traditional investment or intermediate-term trading practices, many additional risks are also assumed. Conversely, while tight risk controls are available through the intraday and scalping styles, the potential for profit may also be limited.
Anatomy Of A Swing Trade
As with most things in the financial markets, setting up and executing a successful swing trade is a process. One must identify an opportunity, define the trade's parameters and then enter the appropriate marketplace.
Opportunity is present in many different markets around the world, through the trade of a vast number of products. Common targets for swing traders are corporate stocks, assorted futures contracts and currencies. Each variety of financial instrument requires distinct planning as items such as contract expiration, rollover and margin requirements are specific to the asset being traded.
However, there are several characteristics exhibited by an ideal instrument for this type of approach:
- Asset liquidity: Asset liquidity refers to the ability of an asset to be readily converted into cash. Because swing trading deals in relatively short-term durations, items that are not openly traded on a public market, or have substantial fees associated with "cashing out," are not viable options. Financial instruments that are quickly and cheaply converted to cash are required.
- Market participation: Frequently traded products supply the market liquidity necessary for efficiently entering and exiting swing trades. High traded volumes and open interest are two indications of robust market participation.
- Volatility: Aside from sustaining a profit, the objective of swing trading is to capitalise on market moves that are larger than those typically experienced on intraday time frames. In order to justify the risk assumed by the longer duration and overnight holding period, a greater reward must be possible. Markets in a compressional or rotational phase are not ideal as there is simply not enough pricing volatility to generate an adequate gain.
Assigning the parameters of the trade is the second crucial part of the process. There are several key aspects of a swing trade that must be defined before entering the market:
- Trade selection: Technical indicators, algorithms or discretionary criteria are often used to identify a trade setup and define market entry.
- Money management: This may be the most important contributor to profitability. A comprehensive money management plan must be in place in order to preserve profit from unwarranted risk. For a swing trading approach, the plan needs to clearly define the risk vs. reward scenario for each trade setup.
- Trade management: In an attempt to promote consistent behaviour within the marketplace, order types used to define market entry, profit targets and stop losses must be clear before the trade is initiated. Because the duration of a swing trade is measured in days, there is often time to make planned alterations to management parameters.
After an opportunity is recognised, an ideal candidate is chosen and a comprehensive trading plan is in place, it is time to enter the market. Although the success or failure of a specific trade is sometimes unclear, the process behind its initiation must be sound to ensure longevity in the marketplace.
Swing trading is often the preferred style of new and veteran traders alike. It affords the ability to realise substantial profits while avoiding the second-by-second pressure cooker associated with shorter time frames. Additionally, the amount of time required to swing trade is considerably less than is necessary for day trading and scalping. Many individuals work full-time while engaging in this style of trade.
It is up to the individual to decide which type of trading or investment is most suitable with respect to available time, capital and risk tolerance. Although one type of trading may be attractive due to higher potential yields or tighter risk controls, it simply may not be the best course of action.
Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…