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Swing trading has been described as a kind of fundamental trading in which positions are held for longer than a single day. Most fundamentalists are actually swing traders since changes in corporate fundamentals generally require several days or even a week to cause sufficient price movement to renders a reasonable profit. 

But this description of swing trading is a simplification. In reality, swing trading sits in the middle of the continuum between day trading to trend trading. A day trader will hold a stock anywhere from a few seconds to a few hours but never more than a day; a trend trader examines the long-term fundamental trends of a stock or index, and may hold the stock for a few weeks or months. Swing traders hold a particular stock for a period of time, generally a few days to two or three weeks, which is between those extremes, and they will trade the stock on the basis of its intra-week or intra-month oscillations between optimism and pessimism.

The Right Stocks for Swing Trading

The first key to successful swing trading is picking the right stocks. The best candidates are large-cap stocks, which are among the most actively traded stocks on the major exchanges. In an active market, these stocks 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 stock reverses direction.

The Right Market

In either of the two market extremes, the bear market environment or raging bull market, swing trading proves to be a rather different challenge than in a market between these two extremes. In these extremes, even the most active stocks will not exhibit the same up-and-down oscillations as when indexes are relatively stable for a few weeks or months. In a bear market or bull market, momentum will generally carry stocks for a long period of time in one direction only, thereby confirming the best strategy is to trade on the basis of the longer-term directional trend.

The swing trader, therefore, is best positioned when markets are going nowhere—when indexes rise for a couple of days, 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 stocks and indexes roughly at the same as their original levels, but the swing trader has had many opportunities to catch the short-term movements up and down (sometimes within a channel).

Of course, the problem with both swing trading and long-term trend trading is success is based on correctly identifying what type of market is currently being experienced. Trend trading would have been the ideal strategy for the bull market of the last half of the 1990s, while swing trading probably would have been best for 2000 and 2001.

Using the Exponential Moving Average

Simple moving averages (SMAs) provide support and resistance levels, as well as bullish and bearish patterns. Support and resistance levels can signal whether to buy a stock. Bullish and bearish crossover patterns signal price points where you should enter and exit stocks.

The exponential moving average (EMA) is a variation of the simple moving average that places more emphasis on the latest data points. The EMA gives traders clear trend signals and entry and exit points faster than a simple moving average. The EMA crossover can be used in swing trading to time entry and exit points.

A basic EMA crossover system can be used by using the nine-, 13- and 50-period EMAs. A bullish crossover occurs when the price crosses above these moving averages after being below. This signifies that a reversal may be in the cards and an uptrend may be beginning. When the nine-period EMA crosses above the 13-period EMA, it signals a long entry. However, the 13-period EMA has to be above the 50-period EMA or cross above it.

On the other hand, a bearish crossover occurs when the price of a security falls below these EMAs. This signals a potential reversal of a trend, and it can be used to time an exit of a long position. When the nine-period EMA crosses below the 13-period EMA, it signals a short entry or an exit of a long position. However, the 13-period EMA has to below the 50-period EMA or cross below it.

The Baseline

Much research on historical data has proven in a market conducive to swing trading, liquid stocks 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 (2002), Dr. Alexander Elder uses his understanding of a stock'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 stock chart, he or she goes long at the baseline when the stock is heading up and short at the baseline when the stock is on its way down.

So, swing traders are not looking to hit the home run with a single trade—they are not concerned with the perfect time to buy a stock exactly at its bottom and sell exactly at its top (or vice versa). In a perfect trading environment, they wait for the stock to hit its baseline and confirm its direction before they make their moves. The story gets more complicated when a stronger uptrend or downtrend is at play: the trader may paradoxically go long when the stock dips below its EMA and wait for the stock to go back up in an uptrend, or he or she may short a stock that has stabbed above the EMA and wait for it to drop if the longer trend is down.

Taking Profits

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 stock 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).

The Bottom Line

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 the duration that does not lead to distraction. By contrast, trend trading 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 that long without getting distracted. On the other hand, trading dozens of stocks per day (day trading) may just prove too white-knuckle of a ride for some, making swing trading the perfect medium between the extremes. (For related reading, see: Scalping vs. Swing Trading.)

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