Swing Trading- Repeating Smaller Profits Over Time, How to Apply, What to look?

Trading is an age old pursuit followed by a section of market participants involving methods that entails active participation in the financial market, which implies active buy and sell strategies as opposed to investing, which typically often involves buy and hold strategy.

A trader, typically a person who buys and sells tradable financial instruments in the capacity of an agent, hedger, arbitrageur, or speculator, often deploy many trading styles and strategies in the course of active participation in the market.

One such of many strategies is swing trading

Swing trading is a simple strategy that usually focuses on taking smaller exposure in short-term trends, i.e., positions are held for short-term (usually more than a single day) and losses are cut quickly.

• The end result of swing trading is smaller profits, but the ideology behind it is in the repetition of the process, which ultimately could be compounded over time to give excellent returns.
• A better idea of swing trading could be gathered through its holding period, which lies somewhere between the holding period of day trader and trend trader; thus, a swing trader holds a financial instrument for generally a few days to two or three weeks.

Let’s get started with swing trading strategy and steps followed by a swing trader

• Basics of swing trading are in targeting smaller profits of say 10 per cent or even 5 per cent or less in tough market conditions, repetitively, over a period of time. Such returns might not seem life-changing in the first stance, but the idea is to garner such gains over a span of a few days to 2 weeks while cutting losses short.
• Cutting the loss short is one of the founding ideology of swing trading along with generating smaller returns over a span of a few days to weeks. In this way, the cumulative result remains attractive.

The daily life of a retail swing trader usually starts with gathering information, identifying potential trades, execution of identified trades, and closing previous positions at either loss or profit.

Swing Trading Strategies

One of the most popular swing trading strategies is the one which consists of the foundation stone of swing trading, i.e., buying above the break of consolidation and acting contrary in the opposite situation.

• Most of the typical subjective technical analysis rule applies to swing trading strategies such as the knowledge of a prior trend, applying confirmation rule to avoid fake swings, and trailing stops when targeting high swing potential.
• The second strategy of swing trading is to select a range of trading session and buying above the breach of a recent high or selling below the recent low of the selected range.

Let’s discuss both of them in great details

• Consolidation is defined as the fixed price range of a tradable instrument, between which an instrument has been oscillating for a while. A break and confirmation of such a consolidation range gives a swing trade a good risk reward potential.
• However, while a break above a consolidation is easy to justify as it is just a breach of prices above the fixed price range, in which, the instrument has been trading for a while, confirmation rule and their application could be troublesome for some retail traders, as there are no standardised formula or principle which could define or back confirmation as it varies from situation to situation.

Some of the most common confirmation rules that could be applied post identifying a consolidation break swing are as below:

Close Filter

• A significant problem from a trader’s standpoint is that when the penetration is occurring, there is usually no other confirming evidence until after the close of the trading session. While some traders prefer to act immediately on a swing, it could become risky.
• A less risky action is to wait till closing, and many traders apply closing price as a filter to confirm a swing break, i.e., if a swing closes above the resistance or support line, it is taken as a confirmation signal of a breakout and vice versa, and backed by volume strength.

Point or Percentage Filter

• Another confirmation method is to look for a breakout zone either percentage beyond the breakout level or certain number or fraction of points. Traders usually set a percentage filter of 1 to 2 per cent while some even combine percentage filter with the close filter and argue that if a breakout could penetrate beyond the percentage zone and give a closing, it must be true.

Time

• Rather than looking simply at prices, some traders use time as a filter to confirm a breakout. The idea is that if a breakout sustains some time above the support/resistance line, it should be a real breakout.
• Some traders even combine time filter with higher order time filter and prefer to look for two consecutive close and a weekly close above support/resistance to confirm a breakout.

Volume

• An ideal breakout should usually accompany a good trading volume, and heavier trading volume has been associated with breakout confirmation.
• Volume is the secondary tool for traders, and a good understanding of volume in confirming breakouts could be a very handy tool.

To Know More, Do Read: Volume Analysis- How to Utilise the Secondary Tool To Generate Alpha?

The above price rules have one obvious drawback that they do not incorporate or consider price volatility. By nature, some financial instruments such as commodities are more volatile in nature, and tools which consider price volatility in their construction could be used to confirm breakouts while separating them from intraday penetration or specialist breakouts.

Standard Deviation

• SD of returns, based on the percentage change in price, is the basis for most options and other derivative models and uses the complete set of price over some past time period.
• However, SD used in the calculation in other volatility indicators such a Bollinger Band, Average True Range, is usually preferred by traders as it removes the influence of the underlying trend and helps in assessing the volatility of the trend.

A consolidation break, followed by a number of above confirmation rule, confirms a swing trade.

The other renowned strategy of the swing trade is to select a range of trading sessions and enter the market (buy or sell) on the breach of the recent high and recent low, respectively.

There are many methods to do the same, some of which are as below:

• Gann Swing Method

To spot a Gann Swing, a trader needs to be familiar with some bar charts terminology and should look for an up day followed by a down day and a down day followed by an up day.

An example of the Gann swing is as below

FMG Daily Chart (Source: EODHD/Others Eikon Thomson Reuters)

• First, identify the above-mentioned pair of an up day followed by a down day and a down day followed by an up day.
• Post identifying such pairs connect them to draw the swing.
• Gann method suggest buying when the price breach the previous high; however as could be seen on the above chart, such a swing (marked as one) could be breathtaking for some traders, as it penetrated the resistance line but quickly failed to sustain.
• The ideal way to deal with such a swing is to either keep the target percentage small while trailing the stop loss to the breakout point once prices rise slightly after penetration or wait and use above-suggested confirmation parameters.

Trading is not just science, as following a strategy however good requires a rational trader behind the desk to execute the plan. A good trader does not focus too much on being right, but rather on being safe and sustaining the game in the long term.