Swing trading sits in the middle of the continuum between day trading and trend following. Swing traders hold a particular CFD for a period of time, generally between a few days and two or three weeks, and trade the CFD on the basis of its intra-week or intra-month oscillations between optimism and pessimism.
The first key to successful swing trading is picking the right CFDs. The best candidates are large-cap CFDs that are among the most actively traded CFDs on the major exchanges, for example, Intel, Microsoft, and Cisco Systems. In active markets, these CFDs will swing between broadly-defined high and low extremes, and the swing trader will ride the wave in one direction for a couple of days or weeks, only to switch to the opposite side of the trade when the CFDs reverses direction.
It should be noted that in either of the two market extremes, the bear-market environment or bull market, swing trading proves to be a rather different challenge than in a market that is between these two extremes. In these extremes, even the most active CFDs will not exhibit the same up-and-down oscillations that they would when indices are relatively stable for a few weeks or months. In a bear market or a bull market, momentum will generally carry CFDs for a long period of time in one direction only, thereby ensuring that the best strategy will be to trade on the basis of the longer-term directional trend.#
The swing trader, therefore, is best positioned when markets are going nowhere—when indices rise for a couple of days and then decline for the next few days, only to repeat the same general pattern again and again. A couple of months might pass with major CFDs and indices roughly the same as their original levels, but the swing trader has had many opportunities to catch the short terms movements up and down (sometimes within a channel).
Of course, the problem with both swing trading and long-term trend following is that success is based on correctly identifying what type of market is currently being experienced. Looking back over the past few years, trend following would have been the ideal strategy for the raging bull market of the last half of the 1990s, while swing trading probably would have been best for 2000 and 2001. With the 2002 bear market, the best strategy would have been to follow the trend and short everything in sight. As economists and traders would agree, the most accurate insight into trends is viewed in retrospect.
Much research on historical data has proven that in a market conducive to swing trading liquid CFDs tend to trade above and below a baseline value, which is portrayed on a chart with an exponential moving average (EMA). In his book Come Into My Trading Room: A Complete Guide to Trading, Alexander Elder uses his understanding of a CFD’s behavior above and below the baseline to describe the swing trader’s strategy of “buying normalcy and selling mania” or “shorting normalcy and covering depression.” Once the swing trader has used the EMA to identify the typical baseline on the CFD chart, he or she goes long at the baseline when the CFD is heading up and short at the baseline when the CFD is on its way down.
So, swing traders are not looking to hit the home-run with a single trade—they are not concerned about perfect timing to buy a CFD exactly at its bottom and sell exactly at its top (or vice versa). In a perfect trading environment, they wait for the CFD to hit its baseline and confirm its direction before they make their moves. The story gets more complicated when a stronger up-trend or down-trend is at play: the trader may paradoxically go long when the CFD jumps below its EMA and wait for the CFD to go back up in an uptrend, or he or she may short a CFD that has stabbed above the EMA and wait for it to drop if the longer trend is down.
When it comes time to take profits, the swing trader will want to exit the trade as close as possible to the upper or lower channel line without being overly precise, which may cause the risk of missing the best opportunity. In a strong market, when a CFD is exhibiting a strong directional trend, traders can wait for the channel line to be reached before taking their profit, but in a weaker market they may take their profits before the line is hit (in the event that the direction changes and the line does not get hit on that particular swing).
Swing trading is actually one of the best trading styles for the beginning trader to get his or her feet wet, but it still offers significant profit potential for intermediate and advanced traders. Swing traders receive sufficient feedback on their trades after a couple of days to keep them motivated, but their long and short positions of several days are of ideal duration not to lead to distraction. By contrast, trend following offers greater profit potential if a trader is able to catch a major market trend of weeks or months, but few are the traders with sufficient discipline to hold a position for that period of time without getting distracted. On the other hand, trading dozens of CFDs per day (day trading) may just prove too great a white-knuckle ride for some, making swing trading the perfect medium between the extremes.