My try at explaining swing trading

What is Swing Trading ?

Stock trading beginners need to decide what sort of trader they are going to be - a day trader, a swing trader or a long-term buy-and-hold value investor. A day trader, as the name implies, opens and closes positions within the same day, often more than once and sometimes holding a position for just a few minutes. They base their decisions on very rapid chart and price movements - often they will decide the night before what they will trade the follwing day and when the stocks or indices hit the price they have been expecting then they will buy or sell in line with their plan. Day trading takes a lot of knowledge and skill and is not recommended for beginners to stock trading.

Long-term buy-and-hold means just that. You buy a stock because you think it is cheap or undervalued by the market and then you hold it for a long time (years usually). Warren Buffett, the greatest modern exponent of long-term investing says the best length of time to hold a stock is "forever". He has got very rich by doing just that, but it does require that you be able to understand (and believe) company accounts and that you are willing to invest the time needed to dig out gems that you are confident will rise over time. You can also of course just follow what Warren Buffet does - see Warren Buffett - this is known as coattail investing and is a good idea if you are prepared to wait at least 5 years to see a meaningful return on your money.

The third stock trading strategy you can adopt, which is in fact followed by a lot of people is known as swing trading. In swing trading you buy (or sell) a stock for a few days or weeks, although generally 2 to 5 days, when it is at the bottom of a channel, in the expectation that it will turn around and move up to the top of the channel, at which point you sell and take your profit and look for another trading opportunity. It is similar to day trading except for the time-scale. You don't need to understand the fundamentals of the company or even when they sell.

In swing trading, you still have to decide which stocks to trade, so rules have been devised that help swing traders spot good trading opportunities.

First, you need to find a stock (or an index, or whatever it is that you wish to trade) that is in a trend. A 'trend' means that the stock has been heading higher or lower recently, you do not want a stock that is going sideways. In swing trading you need a minimum of volatility at least. You also need to find repeating and predictable patterns in a stock's chart. If a stock is acting in a predictable manner then you have a chance of predicting what it is going to do next. What you are looking for is a stock (or index etc...) that is likely to move between 5% and 10% up or down. Once you have found such a stock then you need to assess the risk/reward ratio. You are looking for something where the reward outweighs the risk. If the risk is high but potential rewards are low or average then you look for something else.

Swing traders generally apply a number of criteria to the stocks they are considering trading. 1 - the stock price needs to be over $10. 2 - the daily volume should be higher than 500K shares. The reason for these criteria is that market makers find like to manipulate prices to separate traders from their money and they find it easier to manipulate the prices of low volume, low cost penny stocks. So trying to apply swing trading to penny stocks is not recommended, they are too unpredictable.

To help you find a potentially good trade, you also need to understand how to analyze basic stock charts. Most stock traders these days use so-called "candlestick charts", these are analyzed using the stock price plus the 5-day, 10-day, 20-day and 50-day moving averages (although some swing traders like to mix and match their moving averages like using the 10-day simple moving average with the 30 day exponential moving average - but as a beginner it is probably better to learn the basics first). Any basic investing site will automatically give you a chart of the stock price you are interested in along with any moving averages you care to include. A moving average is simply the average price of a stock over a given period of time, but it is important to use them as they are what everyone else uses and as a small trader you need to follow the crowd, not get trampled to death trying to go the other way.

So you are looking for a stock that is in a trend. In addition to this the closing price needs to be above the 10-day and the 20-day "simple moving average" (s.m.a.) and the 10-day s.m.a. needs to be above the 20-day s.m.a.. and they both need to be trending upwards (see your friendly real-time stock site to get the chart for this).

One final point - if the 5 day moving average is heading down then it is not a good idea to buy that stock, look for a stock where the 5-day moving average is heading up.

As mentioned above, swing trading stocks and indices is all about the risk/reward ratio. You will never be able to make every trade a winning trade, so you need to limit your risks and maximize the rewards. To do this use a strategy such as below whenspending your money.

1. Buy in stages. If a stock gaps up as soon as the markets open 1% to 2%, then buy with just half the amount of money you intend using. Wait to see what happens. If the stock price continues to head up then you can buy more.

2. If a stock price gaps up 2% to 3% when the markets open, then only use a quarter of the money you intend using for that trade.

3. If the stock gaps up by more than 3% when the markets open, then the trade is too risky and the potential reward is too low so look for something else.

The profit aim in swing trading is around 5% to 10 %. The reason for this small profit margin is that once a stock has moved up 5 or 10% then it will probably hit 'resistance' and turn around and come back down. So the aim is to you close your trade for around 7% profit, wait for the stock price to fall back again and then do it all over again!

If, despite your best chart reading efforts, the stock price does not move up after you have bought it then close the position anyway, you probably got it wrong.

Stop losses.

What are stop losses? Stop losses are designed to ensure that your losses are limited. A stop loss is a decision to sell the stock if it falls back by a certain amount, no matter what. Too many people hang on to a stock they have bought when it goes down, in the hope that it will come back up and they can get their money back. This is a very bad strategy (personal experience can confirm this!). With a stop loss you limit your losses and live to fight another day. You are bound to make losses but the aim in swing trading is to ensure that your gains are greater than your losses.

You must therefore set your stop loss at the same time as you place your trade (or before if possible). Then if the trade goes wrong, the software on the trading site you are using should automatically get you out of your position. The actual percentage of your stop loss may vary, but if your profit objective is between 5% and 10% then your stop loss needs to be around 4%, meaning you are only willing to risk 4% of your money on that trade.

In addition to the the stock price and the moving averages there are other patterns swing traders look for such as candlestick patterns - the main bullish patterns you need to be able to recognize are - the Hammer, the Engulfing pattern, the Piercing, the Harami, and the Doji.

One final piece of basic advice for all stock traders is "don't buy a stock that is below its 200-day moving average" - look at what happened to some of the major banks recently when they fell below their 200-day moving average ! It wasn't pretty.