Swing trading, a short- to medium-term trading strategy that looks to profit from price swings in a stock or other financial asset, is one of the most popular strategies for stock traders. However, it comes with the risk of significant losses. Over at Bankrate, Brian Baker offers a primer on the basics of swing trading, what its benefits are, and what to look out for.
While day traders typically close out their positions at the end of each day, swing traders will hold positions for days, weeks, or even months. Once a swing trader has identified a stock they think will move, the trader will establish a position and attempt to profit from the “swing” over the coming days or weeks. Swing traders typically establish their positions after the swing has started and exit before it has ended.
Common strategies that swing traders use include support and resistance, simple moving averages, and fundamental analysis. With support and resistance, swing traders may look to buy off the support levels — which are created at a price where buying interest is strong enough to “support” a stock’s price — and sell near resistance levels, which are where selling pressure overcomes buy orders.
Moving averages, meanwhile, are a way to smooth out a security’s price movements and eliminate noise from the market. When a short-term moving average moves above a long-term moving average, it could mean a bullish trend, whereas a move below a long-term average could indicate a bearish turn.
Though most swing traders rely on technical analysis, things like earnings announcements and economic indicators can influence a stock or the overall market. Holding a position in a stock going into an earnings announcement could mean you’re betting on the company’s results more than its trading pattern.
Swing trades can capture large returns in a short period of time, and if they’re made through stop-loss orders, which allow orders to be placed at a specific price, that can severely limit risk. Plus, swing trade positions don’t need to be monitored every second of the day.
However, they are subject to overall market risk and may suffer when unanticipated events occur. Not to mention, swing traders may miss out on the long-term investment returns available through the stock market. Additionally, short-term capital gains are taxed at ordinary income rates.
As with any form of trading, swing trading comes with the risk of significant losses. While they can be mitigated by using stop-losses, the risk of loss can’t be eliminated entirely. When investing for the long term in a diversified portfolio, time is on your side. That’s not the case with short-term trading, however. Anything can happen over a period of days or weeks.
Frequent swing trading can also incur higher costs than a long-term strategy. Though most online brokers don’t charge commissions for stock and ETF trades, there can be hidden costs of trading such as being out of the market during a large upswing.
Swing trading can be a profitable strategy for those adept at using technical analysis. It also has the potential to work in both bull and bear markets. It’s not without risks, however, and could yield worse returns than a long-term strategy. Bankrate suggests that those considering swing trading should test their strategies with a small portion of their portfolios first.
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