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Swing trading setups

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Swing trading refers to the practice of trying to profit from market swings of a minimum of one day and as long as several weeks. In contrast to swing traders, day traders usually are in and out of the market in one day and trend traders often hold positions for several months. So, in terms of length of holding a trade, swing traders are in between day traders and trend traders.

Each type of trading has its advantages and disadvantages. The appeal of swing trading is that it provides plenty of opportunities to trade; the dollar risk per trade are lower than with trend trading because of closer stops; it provides greater profit opportunity per trade than day trading; and quick rewards provide emotional satisfaction. The downside of swing trading is that you must work hard all the time to manage trades; you are quite likely to miss major moves where huge profits can be made; and frequent trading results in higher commission costs.

A good argument can be made that beginning traders would be well-served to start with swing trading as it allows enough trading action to gain experience; losses can be kept to acceptable levels with proper stop loss techniques; and it provides a good perspective to learn about both the short-term and long-term movements of markets.

Looking for Swing Trading Candidates

Markets spend most of their time going nowhere. They typically rally a few days, pause, decline a few days, and rally again. Small swings are more common than big trends. By the end of a month, the market may be higher or lower, but it has traveled up and down several times. The art of swing trading is capturing profits from those small swings.

Swing traders should select their candidates from the most actively traded stocks and ETFs that show a tendency to swing within broad well-defined channels. Virtually all trading platforms provide a function to enter channel lines on a price chart. The trader should keep a list of stocks and ETFs to monitor on a daily basis and become familiar with the price action of their selected candidates.

Swing Trading Methods

There are a variety of methodologies to capitalize on market swings. Some traders prefer to trade after the market has confirmed a change of direction and trade with the developing momentum. Others may choose to enter the market on the long side after the market has dropped to the lower band of it price channel – in other words, buying short-term weakness and selling short-term strength. Both approaches can be profitable if implemented with skill and discipline over time.

Here is an example of swing trading:

Identify a stock or ETF where the weekly trend is up and the bottoms on the daily bar chart tend to be short and sharp. Analyze how the stock or ETF has behaved since the beginning of the trend. If the it has returned to the moving average three times and penetrated it by an average of a 1.5% of its price, place a buy order approximately 1% of the instruments price below the moving average, a little more shallow than the previous declines.

After entering a swing trade, place a protective stop reasonably close to your entry point. Swing trading is a high-wire act, requiring a safety net. Stops and money management are essential for your survival and success.

Take profits near the upper channel line. It the market is strong, you can wait for the channel line to be hit. If it’s weak, grab your first profit while it’s still there. What if a strong swing overshoots the channel line? An experienced trader may shift his tactics and hold a little longer, perhaps until the day when the market fails to make a new high. A beginning trader is better advised to take profits after the channel line has been hit as it’s important to learn to take profits in accordance with one’s trading plan.

A trader can measure his or her performance as percentage of the trading channel width. The perfect trade would be buying at the bottom channel line and selling at the top channel line, which would be a 100% performance. If a trader captured one-half of the channel, it would be a 50% performance. The goal is to continually increase the performance percentage of the average winning trade.

As mentioned, other methods can be used to profit from the market’s short-term swings. The important point is to develop a method that works for you; implement it consistently; adhere to explicit money management rules; and keep good records so you can track your progress as a trader.

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Article copyright 2011 by Alex Elder. Reprinted and adapted from Come Into My Trading Room with permission from John Wiley & Sons, Inc. The statements and opinions expressed in this article are those of the author. Fidelity Investments® cannot guarantee the accuracy or completeness of any statements or data. This reprint and the materials delivered with it should not be construed as an offer to sell or a solicitation of an offer to buy shares of any funds mentioned in this reprint.
The data and analysis contained herein are provided "as is" and without warranty of any kind, either expressed or implied. Fidelity is not adopting, making a recommendation for or endorsing any trading or investment strategy or particular security. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before trading. Consider that the provider may modify the methods it uses to evaluate investment opportunities from time to time, that model results may not impute or show the compounded adverse effect of transaction costs or management fees or reflect actual investment results, and that investment models are necessarily constructed with the benefit of hindsight. For this and for many other reasons, model results are not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.
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