How do swing traders make money?
In swing trading, traders take short-term bets with a holding period ranging from a few days to weeks.
The style is called swing trading because traders swing from one position to another, accumulating small profits that add up to bigger profits in a given period.
For example, a swing trader can take 5 trades in a week making a 5% return on each trade to make a 27% return on his trading capital. That’s assuming he is right 100% of the time. In a more reasonable scenario, if the trader is right half the time, and loses 2.5% on each losing trade, the return would amount to 5.4%. That may not sound much, but considering it’s a weekly return, the longer-term returns will be eye-popping due to the effect of compounding.
In fact, a 5% weekly return, compounded, would result in a 10,000 account balance turning into over 126,000 at week 52.
Swing Trading Strategies
Different swing traders deploy different strategies to capture the short-term moves in prices. New traders generally do a lot of trial and error using different strategies and form their strategy that suits their individual preferences.
While most of the trading in swing trading can be dependent on charts and technical analysis, traders with medium-term horizons and higher return objectives also follow fundamentals to have a better conviction on a trade.
Swing trading strategies can be broadly classified into three kinds.
- Range Based
In range-based strategies, traders identify stocks that move to and fro within a range. You can use chart patterns, trend lines, indicators like moving averages, RSI, MACD, or Bollinger bands to zero in on a range. Once the range is established you can go long at the lower end of the range and short at the upper end of the range.
Such ranges can be established in boring, out of favour stocks that are not trending for a long time. The ranges wouldn’t hold true if something changes significantly with the stock.
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- Reversal based
In reversal-based trading strategies, you can look for stocks that are either overbought or oversold and are ripe for reversal. Trading reversals is not as straightforward as it sounds because stocks tend to remain overbought or oversold for extended periods.
Therefore, traders may not want to short a stock right at the top or buy at the bottom. Instead, they would try to enter only when there is enough evidence of the price having been reversed.
- Continuation Based
Continuation based strategies identify signs of continuation of a trend and trade in the direction of the trend.
Traders can follow breakouts or breakdowns from price patterns or use technical indicators to identify trend continuation and trade accordingly.
Other ingredients of successful swing trading
While strategy is an important element of successful swing trading (or other strategies for that matter), it’s also the easiest part to learn.
To make consistent returns as a swing traders, there are other essential components that need to come together for swing trading to be worth anybody’s time.
Here are the most essential components of successful swing trading.
- Reward-risk
Each swing trader has a trading plan that contains the risk taken to make each dollar of return.
This ratio would differ for different strategies and should be skewed towards reward to a degree but that would depend on the next element, which is the win rate.
- Win rate
Win rate is the number of the times you make a profit relative to the total trades you take. A higher win rate allows you to be successful even with a lower reward-risk. As a general rule, the lower your win rate, the higher reward-risk you would need for any reasonable degree of success in swing trading.
- Position sizing
Higher reward-risk and win rate won’t yield much if you diversify too much. Alternatively, it will be too risky if you put all your account in one or two trades. Therefore, to make decent returns in swing trading, you must also develop an optimum position sizing strategy. As a rule, successful swing traders limit the number of positions in their portfolio to 10. Some most successful traders don’t go beyond 5.
- Transaction costs
As swing trading requires you maintain a high churn, high trading costs can eat significantly into the return. Therefore, if your trading costs are too high, you must work on improving the other elements to make meaningful returns. Some trading strategies with low reward-risk and win rate won’t be effective at all if trading costs are too high.
Some successful swing traders
Paul Tudor Jones: Using swing trading, Paul Tudor Jones has built one of the most successful hedge funds in the world. His hedge fund has gone from tiny $30,000 to $8 billion betting on short-term movements and compounding with each successive trade.
Mark Minervini: Mark Minervini is one of the most successful traders who started with under $10,000 and now has a multi million dollar personal fortune, all built on a form of swing trading in the US market.
Jim Simons: Simons built Medallion Fund that delivered 71.8% before fees average annual returns between 1994 to 2014. Though, the trading strategy Simons used isn’t known to the public, he has time and again said that the fund bets on reliable and repeatable short-term patterns and built on the smaller profits to generate big returns.
How to start as a swing trader
If you are starting to trade in stocks or in any other asset class, it’s imperative to start with the strategy. You would have to test several strategies to get to the one that suits your trading style and temperament.
While you are testing the strategies, it’s always a good idea to bet a smaller part of your capital. Once you can confidently make good returns with any strategy on a smaller capital, you can always scale up and put all your chips forward.
Most importantly, you must manage the risk well. Letting the losses run or risking too much on one trade can put you off by a large margin. Remember, the higher the loss, the more returns you need to make to get to break even, let alone making any meaningful profits. So, always think risk first.
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