Swing Trading Strategy Guide | Ally (2024)

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What we'll cover

When it comes to running, are you more of a 100-meter sprint person or a marathon runner? Or maybe you’re somewhere in the middle, like a 10K?

When it comes to trading stocks, you could say that swing trading is the equivalent of a middle-distance race, like the 10K.

Day traders are the sprinters of the active trading world. They practice short-term trading and hold their positions less than a day. Trend traders (a.k.a., the marathoners) use more of a long-term swing trading strategy where positions can be held for a more significant time frame.

With swing trading, or what’s sometimes called momentum trading, trading account positions typically last two to six days, but could last as long as two weeks.

The finish line

The goal of swing trading is to identify an overall trend and capture larger gains within it. Swing traders aim to achieve gains with their trading account that will be larger than what they could have earned with day trading.

Specific risks and commission costs are different and can be higher with swing trading than traditional investment tactics. So swing traders must take note of these to prevent them from eating too much into any profits they might achieve.Furthermore, because swing trading is more susceptible to market volatility, the risk of large losses beyond your initial investment is higher.

Learning the basics

Swing traders don’t go at it alone. They often use technical analysis to help take advantage of a security’s current trend. By identifying both the trend’s direction and its strength, swing traders can hopefully improve their trades.

Chart patterns are one of the most common forms of technical analysis used by swing traders.

Most work with the main trend of the chart. If a security is on an upward trend, a swing trader will “go long” and buy shares, options or futures contracts of that security.

What if the security is trending downward? A trader could short shares or futures contracts (the selling of shares or contracts that have been loaned from a broker with the intent of purchasing them back for less cost in the future), or buy put options (a type of investment where the owner has the right to sell by a predetermined date for a specific price, but isn’t required to do so).

In many other instances, however, neither a bullish or bearish trend is present. Instead, the security is moving in what’s referred to as parallel resistance and support areas. When the stock market is up and then pulls back, the highest point reached before the retreat is the resistance. Once the market starts rising again, the lowest point reached before the climb is the support.

Opportunities exist for swing traders in these non-bull or bear cases as well. They can take a long position near the support area and a short position near the resistance.

Coaching strategies for good form

Whether you’re a bull or a bear (or another investing animal spirit entirely), you can utilize swing trading as part of your investment strategy. But since swing trading involves technical analysis beyond the typical research done on various securities, you can’t just lace up your shoes and head out, so to say. Instead, the following specific swing trading strategies could improve your chances for success.

Bull strategy #1: Play the uptrend.

Trending stocks rarely move in a straight line, like Usain Bolt running the 100 meters. Instead, they usually move in a pattern that looks like a set of stairs. For example, a stock might go up for several days, then down for a few days after that, before rising again.

When several of these zigzag patterns occur back-to-back, the stock is said to be on an uptrend.

Bullish swing traders could look for initial movement upward that’s the major part of a trend, followed by a reversal or pull back. (That’s known as the counter trend.) After the counter trend, you’ll want to see upward movement resume.

Bull strategy #2: Capture gains on the upside.

Since no one knows for certain how long a pull back or counter trend will last, bullish swing traders should consider making a trade only after it appears the stock is on the rise again.

Savvy swing traders can do this by isolating the counter trend move. To start, they’ve got to figure out their entry point. It’s their starting line, or the price they pay to buy an investment. A good entry point can be when the stock trades higher than the pull back’s previous day’s high.

From there, you need to find the lowest point of the pull back — this is your stop out point, or the swing low. If the stock’s price drops below this point, you should sell your position to limit losses.

Next, locate the highest point of the recent uptrend. This is your profit target. If the stock’s price rises to this level (or goes even higher), you should consider selling at least a portion of your position to lock in some gains.

The difference between your profit target and your entry point is the approximate reward of the trade; the difference between your entry point and your stop out point is the approximate risk.

To determine if a swing trade is worth it, consider using this rule of thumb: Two-to-one is a minimum reward-to-risk ratio. In other words, your potential profit should be at least twice as much as your potential loss.

Have a ratio higher than that? That’s considered a better trade. But if it’s lower, it’s worse.

Bull Strategy #3: Know how to enter your trade.

Bull swing traders that purchase stocks could enter their trades using a buy-stop limit order. That’s an order to buy a security at a specified price (or better). But if you’re trading in-the-money options, it’s possible you’ll use a contingent buy order, which involves a simultaneous execution of at least two transactions.

Once a stock or call option position is open, you can then enter a one-cancels-other order to sell as soon as it hits your stop loss price or profit taking price. This kind of advanced order ensures that as soon as one of the sell orders is executed, the other order is cancelled.

We get it — this sounds complicated. That’s why Ally Invest professionals are available to answer any questions that may arise. And our intuitive trading platform lets you manage contingent and advance orders easily and efficiently.

Now, on to bear strategies …

Bear strategy #1: Capture gains on the downside.

Bears can apply tactics used by bulls during an uptrend to potentially take advantage of a downtrend. But since it’s difficult to predict exactly how long a bear rally, or counter trend, may last, you should only consider entering a swing trade after it seems that the stock’s performance is continuing an overall southward trajectory.

How can you tell? While not usually as orderly as an uptrend, downtrends also tend to move in a stair-step or zigzag fashion. Bear rallies, or retracements, are the counter trend.

When a stock heads lower than the counter trend’s previous day’s low, a trader could enter a bearish position.

Just like with bull market investing, you should only consider entering a swing trade after you’ve evaluated the potential reward and risk. You can do this just like the bulls do: Compare the entry point to the stop out and the profit target point.

On a bearish swing trade, the stop out point, or swing high, is the highest price of a recent counter trend. When a stock rises higher than this amount, you can exit the trade to minimize losses. The profit target is the lowest price of the recent downtrend. When the stock reaches this price or lower, you can consider exiting at least some of your position to potentially solidify some gains.

Similarly, the difference between your entry point and your profit target is the approximate reward of the trade; the difference between your stop out point and your entry point is the approximate risk.

Bear swing traders can follow the same recommendation of a reward-to-risk ratio of two-to-one or greater.

Bear strategy #2: Know how to enter your trade.

It’s possible for bear swing traders to submit a trade using a sell-stop limit order. That’s an order to sell a security short once it hits your entry point. Or you could buy an in-the-money put option. If that’s your option, you would use a contingent order to buy the put after the stock price hits the entry price.

For those who want to “off-road” it

Swing traders usually go with the main trend of a security. But some like to go against the grain and trade the counter trend instead. This is typically known as fading, but some might also refer to it as counter-trend trading, contrarian trading, and (our personal favorite) trading the fade.

With fading during an uptrend, you could take a bearish position near the swing high because you expect the security to retreat and go back down. And trading the fade during a downtrend means that you would buy shares near the swing low if you expect the stock to rebound and rise.

But keep in mind: When fading, you’ll want to exit the trade before the counter trend ends and the stock resumes the main trend, whether bullish or bearish.

If you don’t have the speed required for day trading or the long-term attention that trend trading can require, swing trading could be the right investment option for you.

The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. Ally Invest does not recommend the use of technical analysis as a sole means of investment research.