Chapter 1

Swing Trading from A to Z

IN THIS CHAPTER

Contrasting swing trading with other types of trading

Deciding how much time you want to devote to swing trading

Getting strategic by preparing your trading plan

Avoiding the mistakes that many swing traders make

You can earn a living in this world in many different ways. The most common way is by mastering some skill — such as cooking for a restauranter or auto repair for a mechanic — and exchanging your time for money. The more skilled you are, the higher your compensation. The upside of mastering a skill is clear: You’re relatively safe with regard to income. Of course, there are no guarantees. Your skill may become outdated (there aren’t many horse carriage manufacturers operating today), or your job may be shipped overseas. You also have a maximum earning potential given the maximum hours you can work without exhausting yourself.

But there’s another way to make a living. Swing trading offers you the prospect of earning income based not on the hours you put in but on the quality of your trades. The better you are at trading, the higher your potential profits. Swing trading takes advantage of short-term price movements and seeks to earn a healthy return on money over a short time period.

Swing trading is a good fit for a minority of the population. It involves tremendous amounts of responsibility. You must rely on yourself and can’t be reckless or prone to gambling. If you’re not disciplined, you may end up with no income (or worse).

This chapter is an overview to this book and your guide if you’re interested in swing trading.

Understanding What Swing Trading Is (and Isn’t)

Swing trading is the art and science of profiting from securities’ short-term price movements spanning a few days to a few weeks. Swing traders can be individuals or institutions. They’re rarely 100 percent invested in the market at any time. Rather, they wait for low-risk, high reward opportunities and attempt to take the lion’s share of a significant move. Generally, large institutional investors (think of a pension plan or a sovereign wealth fund) can’t swing trade because their size prohibits them from easily moving into and out of a position. Smaller traders, however, can profit from these short-term movements because their size allows them easier entry and exit from liquid positions.

Just what can you swing trade?

Not everything that has a price can be swing traded. Pieces of artwork have prices that rise and fall, but one cannot swing trade them over short periods of time. To be able to swing trade an asset, that asset must be priced continuously (that is, every business day) with price movements of a certain magnitude (so profits can be generated) with low cost of entry and exit.

Stocks fit the bill. So do cryptocurrencies. Commodities (that is, oil, natural gas, gold, silver, and so on) can also be swing traded.

The text of this book is geared to swing trading stocks. But the techniques presented can be applied to other assets — primarily the technical analysis and trading plan sections (Parts 2 and 4) cover this. The fundamental analysis presented in Part 3 of this book is exclusively applicable to stock investing.

The differences between swing trading and buy-and-hold investing

If you’re a buy-and-hold investor in the mold of Warren Buffett, you care little for price swings. Over the long term, equity indexes have tended to rise across countries. Therefore, you prefer to buy quality businesses at discounts to their intrinsic value (also known as their true worth). You pore over financial statements and read the notes to the financial statements. You read through earnings call transcripts (the management presentations given after quarterly earnings results). Short-term price movements are merely opportunities to pick up securities (or exit them) at prices not reflective of their true value. In fact, buy-and-hold investors tend to have a portfolio turnover rate (the rate at which their entire portfolio is bought and sold in a year) below 25 percent — meaning they turn over their portfolio once every four years.

Buy-and-hold investing is an admirable practice, and many investors should follow this approach, because it’s not as time-intensive as swing trading and not as difficult (in my opinion). But if you have the work ethic, discipline, and interest in swing trading, you can take advantage of its opportunities to achieve the following:

• Generate an income stream: Buy-and-hold investors are generally concerned with wealth preservation and growth. They don’t invest for current income because they sometimes have to wait a long time for an idea to prove correct. Swing trading, on the other hand, can lead to current income.
• Time your buys and sells and hold a basket of positions to diversify your risk: The majority of people aren’t interested in closely following their finances and are best served by investing in a basket of domestic and international mutual funds covering stocks over many countries. Swing traders can hold a few securities across asset classes or sectors and generate higher profits than those who invest passively.
• Achieve lower drawdowns than buy-and-hold investing: Sometimes markets become overvalued. Just because a market is expensive doesn’t mean it will tank. Markets often go from being overvalued to even more overvalued. This inevitably sets the stage for a major market crash (think 2000 or 2008). During market crashes, buy-and-hold investors can experience drawdowns of 50 percent or more, meaning a decline in portfolio value from peak to trough. Swing traders, on the other hand, are only in the market when there is opportunity. If the trend is down, swing traders can sit on the sidelines with their cash in tact until sunny days return.

The differences between swing trading and day trading

Opposite the buy-and-hold investor on the trading continuum is the day trader. Day traders rarely hold positions overnight. Doing so exposes them to the risk of a gap up or down in a security’s price the following day that could wipe out a large part of their account. Instead, they monitor price movements on a minute-by-minute basis and time entries and exits that span hours.

Day traders have the advantage of riding security price movements that can be quite volatile. This requires time-intensive devotion on their part. Near-term price movements can be driven by a major seller or buyer in the market and not by a company’s fundamentals. Hence, day traders concern themselves with investor psychology and news flow more than they do with fundamental data. They’re tracking the noise of the market — they want to know whether the noise is getting louder or quieter.

But it’s not all cake and tea for day traders. Because day traders trade often, there is little time to “rest” because any existing trade will need to be exited soon and any new trades need to be identified and researched. Profits per trade are small and the day trader needs volume to generate respectable returns at the end of the year.

Swing traders also must seek out new opportunities, but nowhere near the volume of the day trader. Because price movements span several days to several weeks, a company’s fundamentals can come into play to a larger degree than they do for the day trader (day-to-day movements are due less to fundamentals and more to short-term supply and demand of shares). Also, the swing trader can generate higher potential profits on single trades because the holding period is longer than the day trader’s holding period.