Definition of a Swing Trader
While a day trader usually opens and closes his trades on the same day and a long-term trader can use periods of weeks or months for his trading activities, typical swing traders look for recognisable patterns to exploit over a period of a few days.
Swing traders usually do not use fundamental analysis to guide their trading activities, i.e. they do not consult company financial statements, analyse profit ratios or consider exchange rates, GDP growth rates, or the rate of inflation before making trades.
What they do is to use some or other combination of technical indicators to determine their entry and exit points.
Trading Ranges and Trend lines
An ideal situation for a swing trader is where the market trades in a fairly narrow range, with clearly recognisable upper and lower limits. Such a trader would then enter into a long trade the moment the market ‘bounces off’ the lower trend line and exit the trade as soon as the price reaches the upper limit of the range. At this point, he would often reverse his position and enter into a short trade – in anticipation of the drop in the price he expects to see.
Fig. 11.16(a) highlights the opportunities and problems inherent with this approach. Between the 11th of October and the 4th of November, the price of Brent remained in a relatively narrow range.
Waiting for a pullback after the recent high, a swing trader would have entered a long trade at point A, where he expects the market to turn around. At point B he would he cashed in, making a neat profit in the process.
At this point (B) he could have entered into a short trade, which he then would have exited at point C – where the market dutifully turned around and headed for point D. Repeating this exercise a couple of times he would have made quite a decent profit.
The problem is that real life trading is seldom so simple – otherwise we would all have been rich. At point F, the same trader would have cashed in on his long trade and entered a short trade – only to find out that the market has hit him with a breakout trade. The price did not turn around as expected, but instead it headed for new highs and when it eventually turned around it was far above the level one would have expected using trend lines.
Using Pullbacks and Moving Averages
Another favourite approach of swing traders is to wait for a pullback during a trend and then trade in the direction of the main trend.
They often use a combination of two moving averages to help then time their entry and exit points. Looking at Fig.11.16 (b), such a trader would for example have waited for the price to break through the longer-term 30-day moving average (yellow line) at point A to indicate that an uptrend has started. Then he would watch the market closely until he sees a pullback at point B before entering into a long trade.
Now the shorter-term 10-day moving average starts to play a role. As soon as he sees a pullback in the price and it drops below the 10-day moving average, he would exit the trade – making a tidy profit in the process
Once again, however, reality puts a spanner in the wheel. If we look at the behaviour of the price after this point, it becomes clear that such an approach only works well in a trending market. Once the market becomes range-bound, the approach described under ‘trend-lines’ above becomes much more useful.
Swing Trading and Bollinger Bands
Some swing traders also use Bollinger Bands to guide their swing trading entry and exit points. If we look at Fig. 11.16 (c), we can see why. Entering a short trade at point A and reversing this to a long trade at point B would have given the trader quite a decent profit. The same holds true from points B to C, C to D, D to E, E to F, and F to G.
The clock strikes 12 again at point G, where the price touches the upper limit of the Bollinger band, but does not bounce back. If it clearly broke out of the band at this stage, it would have given a clear signal that unusual price behaviour was one the way, but it did not – instead it ran along the upper limit of the Bollinger band for quite a while before bouncing back.
Swing trading can be a very profitable enterprise if you choose your markets and your indicators correctly. As we have seen, not all indicators work equally well in all types of markets, so you first have to identify whether you are entering a range-bound or trending market before choosing an appropriate indicator to work with.