What Are the Fundamentals of Swing Trading?
Swing trading, known by some as channel trading or channeling, is a trading method using technical analysis to determine the predictable trading range of a given stock and then buying on the low end and selling on the high end of that expected range. Swing trading is characterized by its short term trading strategy. Swing traders rarely hold a position longer than four or five days, and are most often in and out of a trade in the same day. Swing trading is best suited to sophisticated individual investors and day traders.
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Function
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The function of swing trading is to identify a stock trend and trade it for profit. The first step is to determine whether or not a trend exists. Look at the chart for a given stock. Over the past month, is the stock going higher, lower, or staying flat? If the stock is flat, you can forget about it. If there is an identifiable trend to the upside or downside, though, the stock might bear further investigation. The next step is to draw a trend line. We'll use an up trending stock for example. Begin your trend line at the first sign of the up trend. Draw a straight line following the trend of the stock touching the low points of each down day in the up trend. This is the support trend line. Do the same on the other side of the trading range, touching each of the high points. This is the resistance line. See photo for example.
Types
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There are other types of technical analysis that go into swing trading. Of the more useful methods, Bollinger Bands can save a trader quite a bit of time. Developed by John Bollinger in the 1980's, Bollinger Bands are like fluid trend lines that follow the price changes in a stock. They show real time support and resistance levels. Another useful type of technical analysis is Moving Average Convergence/Divergence (MACD). MACD tracks the moving average price of a stock and measures short term trends against longer term trends. A convergence of the lines usually indicates a coming change in the trend.
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Time Frame
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Swing trading is very short term. Swing traders identify a trend and then wait for a spike in volume to carry the stock in a predictable direction. When volume peaks or the stock price reverses, swing traders get out of the trade as quickly as possible.
Potential
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The potential for swing trading is highest when the overall market has no particular bias. In other words, swing trading is less effective in an obvious bull or bear market. When the overall market is persistently heading in one direction, it is more difficult to identify those stocks that are trending versus those just following the rest of the market.
Warning
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Swing trading is very popular and therefore there are many resources available to learn this trading method. As with any investment strategy, there are risks involved and swing trading is best executed by those investors with a dispassionate analytical mindset who don't care about the underlying fundamentals of a given stock. Becoming emotionally attached to a stock when your trading discipline clearly demands selling it is a recipe for financial disaster.
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