Most people know about long-term investing and day trading. They know that the general between difference the two is buy-and-hold vs. buy-and-sell. And they know that long-term investing is lower risk and that day trading is higher risk. What most people don’t know is that there is a middle ground, which is swing trading.
The Swing Trade
Let’s cover the differences in strategies a little more specifically prior to moving forward. With long-term investing, you’re holding a stock for at least one year. These investments are based on the fundamentals of the company. With day trading, you’re basing your trades–not investments–on technical analysis and exiting out of all positions prior to the market closing. With swing trading, you’re holding a position between two days and two months. However, most positions will be held between three days and three weeks. The goal here is simple: to capture momentum.
Everyone is different, but all swing traders use technical analysis to figure out the next move. Technical analysis is the opposite of fundamentals as the company’s financial situation plays no role. These trades are all about chart patterns, and most of them are based off of moving averages, cup-and-handle patterns, head-and-shoulder patterns, flags, and more. If you’re not familiar with the above terms, that’s okay. These are easy chart patterns to study and learn. The most important thing to remember is that swing traders are looking for breakouts. A breakout means that the stock has moved higher and has momentum.
Imagine there’s a train chugging its way up a 20,000-foot mountain. This train has been struggling for a while and can’t seem to get above 5,000 feet. One day, it moves higher than 5,000 feet, then to 5,500 feet and 6,000 feet. This train has momentum. Your job is to get on board, but only for a while, not for the whole trip. You might plan to ride this train to 10,000 feet before hopping off because it might lose its momentum and slides back down the mountain again. This leads us to one of the most important points regarding the pros and cons of swing trading.
Pros & Cons
The biggest pro is that if you capture momentum correctly, you will have a lucrative gain in a relatively short period of time. The perceived biggest negative is that if you hop off that train and it keeps chugging up that mountain, you left a lot of money on the table. However, a win is a win. The real biggest negative is that you’re holding your position on nights and weekends. If negative news were to come out, the stock could suffer a gap-down.
Most traders will set up a stop-loss so they minimize losses. This is highly recommended. The problem is that stop-losses have a kryptonite, which is a gap-down. If bad news comes out and the price of a stock plummets from $20 to $15 and your stop-loss is set at $18, it will not trigger a sale because the gap-down means your price target was passed over. While you cannot completely avoid gap-down situations, you can at least minimize the potential of their occurrence. You can do that by never holding positions where a company is about to announce earnings and by never holding positions when the Federal Reserve is about to speak.