Swing Trading


  1. Introduction to Swing Trading
  2. Fundamental Approach to Swing Trading
  3. Chart Patterns Approach
  4. Elliot Wave Analysis
  5. Candlestick Patterns
  6. Technical Analysis Approach
  7. Risks of Swing Trading
  8. Final Thoughts

Introduction to Swing Trading

Swing trading is an approach where traders aim to identify a trend, initiate a trade, and leave it open for a few days until the new trend ends. It is a different approach from day-trading and long-term trading mostly because of the time it takes to leave the trend open. In day-trading, traders open and close trades within a day to avoid the overnight risk while in long-term trading, traders leave their trades open for weeks and months. In this article, we will look at a number of key swing trading strategies that professionals use. The approaches will be divided into three: the fundamental approach, the chart patterns approach, and the pure technical analysis approach. Finally, we will look at the key risks that come with the swing trading approach.

Fundamental Approach to Swing Trading

Fundamental analysis is the strategy of using the market news and economic data to make trading decisions. The strategy is useful because of the integral role the market data and news plays in the financial market. For example, the dollar always reacts when the Bureau of Labor Statistics (BLS) releases the employment numbers. It also reacts sharply when the Fed makes its interest rates decision. Therefore, the goal of swing traders using fundamental analysis is to predict how the data or news will come out and how the currency pairs will react.
A good example of swing trading in action was during the Brexit referendum. While most polls showed that the remain campaign was going to win, some traders crunched data that showed that the leave campaign was winning. As a result, these traders shorted the sterling, which made significant declines in the following days. The same can be said about the Trump election in 2016 and how the market reacted.
While there is much data in the market, swing traders focus on a few of them. Some of the most important economic data that swing traders look at are inflation, employment, manufacturing and non-manufacturing PMIs, housing starts, and consumer confidence among others. When these numbers are released, it usually tells the market about the strength of the economy and how the central bank may react. For example, the EUR/USD pair tends to fall when there is a streak of better-than-expected economic data. This is because it signals that the Fed could be forced to hike interest rates.
As such, fundamental swing traders follow three steps in trading. First, they identify the market-moving data or news. They use the economic calendar and the major news sources to identify the likely news or data. Second, they analyze the data using their own strategies. Finally, they come up with potential scenarios of what will happen after the data is released.

Chart Patterns Approach

Most swing traders use chart patterns to identify when new trends are forming. These patterns are useful because they can tell you how the currency pair will trade. To use these patterns effectively in swing trading, the first most important thing to do is to use the correct timeframes. In swing trading, the most ideal timeframes to use are usually between hourly and 12-hours. It is wrong to use a 15-minute chart to open a trade that will be left open for a few days. After setting up the charts, traders consider a number of patterns to make trading decisions.
Broadly, there are two types of charts in the financial market. A trending chart is one that is moving upwards or downwards. A consolidation chart is one that is struggling to find direction. The goal of any swing trader is to buy a currency pair that is trending upwards or short a pair that is moving downwards. They use the consolidation charts to identify when a breakout will likely happen. There are a number of chart patterns that traders use in swing trading.

Elliot Wave Analysis

A common swing trading strategy is that of Elliot Wave analysis. This is a strategy that was developed by Ralph Elliot after he spent time looking at chart patterns. In his analysis, he found out that the market tended to trading in a series of five and three waves. He called the first five waves impulsive waves and the other three corrective waves. A good example of Elliot Wave at work is shown in the USD/JPY chart below.

Elliot Wave Chart

Source: TradingView
In swing trading that uses Elliot Wave analysis, the goal is to identify the starting point of a wave and then using the various rules to determine how it will move. As shown above, a good starting point of an Elliot Wave is when there is a solid top or bottom. In the chart, this starting point came after the pair reached an important resistance level.
After identifying the source, you need to understand the rules that must always be there for the wave to happen. First, the second wave should never retrace more than 100% of the first wave. In most cases, this retracement is usually between 50% an 61.8%. Second, the fourth wave should never retrace more than 100% of the third wave. In most cases, it usually retraces between 38.2% and 50%. Third, the third wave is never the shortest wave. It usually moves beyond the end of the first wave. As shown above, wave 2 and 4 tend to move against the general trend.
After the impulse wave of the Elliot Wave is formed, a corrective wave then happens. There are four primary types of corrective waves. These are the zigzags, flats, triangles, and double threes. The zigzags can either be single, double or triple while flats are either regular, expanded, or running. Th triangles are either ascending, descending, contracting, and expanding.
In swing trading, the goal of traders using the swing trading strategy is to identify when the wave is starting to form and initiate the trade. A better strategy is that of identifying the third wave, which is usually the longest and moving with it. Another better tip for using Elliot Wave strategy well is that of combining it with the Fibonacci Retracement tool.

Candlestick Patterns

Another way of using chart patterns in swing trading is that of using the candlestick patterns. Swing traders use the concepts of candlestick analysis to make decisions on the direction of the currency pairs. There are more than 20 candlesticks patterns that you can use to identify when a new trend is about to form or when a reversal is expected.
The most common types of candlestick patterns are Doji, abandoned baby, harami, morning start, evening star, hammer, inverted hammer, hanging man, shooting star, dark cloud cover, and three green soldiers. A good example of how you can use candlestick patterns is in the Shooting Star pattern that is shown in the chart below. When a shooting star happens, it is usually an indication that that the pair will continue moving lower.

Candle Stick Analysis Chart

The example below shows the inverted hammer, which is a sign that the pair will continue moving higher.

Candlestick Chart Inverted Hammer

Technical Analysis Approach

Another strategy commonly used in swing trading is that of technical analysis. In it, the traders use the various types of technical indicators to decide whether a new trend is being formed.
Broadly, there are two main types of technical indicators. Lagging indicators give signals after the event has happened while leading indicators give signals before a trend happens. Leading indicators are mostly known as oscillators and include indicators like relative strength index (RSI), relative vigor index (RVI), stochastics, and average true range. Lagging indicators include the likes of moving averages, average directional index, and parabolic SAR.
In technical analysis, the goal is usually to find when new trends are starting and when there are reversals. When a new bullish trend is forming, the goal of the trader is to place a buy trade. When a bearish trend is forming, the goal is to short and benefit as the price declines.
Traders use different strategies when using technical analysis. A common one is that of combining two or more exponential moving averages as shown in the chart below.

Swing Moving Averages Chart

As you can see in the chart above, the USD/JPY pair was struggling to pass the double top position shown in red. At the same time, a 14-day and 28-day exponential moving average was applied on the chart. When the longer-term moving average crossed the shorter-term EMA, a new bearish trend was confirmed. A similar occurrence is shown in the NZD/USD pair shown below.

Swing Moving Averages Chart Crossover

Another common technical analysis method that is commonly used is that of combining two or three indicators to identify or ‘measure’ the strength of the indicators. In the chart below, I have added the Average Directional Indicator (ADX), which is used measure the strength of a trend. As shown, the ADX indicator continued to rise as the NZD/USD pair declined.

Swing Trading Combined Charts

Another common strategy is that of using oscillators like the Relative Strength Index (RSI). In most cases, the RSI and other oscillators are used to identify overbought and oversold positions. When the price of an asset is oversold, it is usually a signal to buy and when it is overbought, it is usually a signal to sell. A good example of this is shown on the NZD/USD pair below.

Swing Trading Oscillator Chart

However, when used by themselves, oscillators can lead to false signals. Therefore, it is usually recommended that you combine it with other indicators. In addition, it is usually recommended to combine all these indicators with volumes.
In technical analysis, other than the indicators, there are other useful concepts that you need to know about. First, you need to know how to identify the support and resistance points. A support is a floor where the price of an asset finds it difficult to pass while a resistance point is a ceiling where the price finds it difficult to pass when moving upwards. These support and resistance points are so important because they tend to key points of reversals.
In the NZD/USD pair below, you can see that it is having difficulties passing the 0.6940 resistance level. After struggling to cross this level, the pair formed a triple top and the downward momentum prevailed. These areas of support and resistance are essential when deciding where to place the stop loss and take profit.

Swing trading support and resistance chart

Risks of Swing Trading

All types of trading come with its own risks. The same is true when it comes to swing trading. Some of the key risks that comes with the strategy are:

Overnight Risk

In forex, markets are usually open 24 hours every day Monday to Friday. This means that data flow from other countries could have significant implications in the market. As such, it is common for original thesis to change in overnight trading. A good example is what happened in 2015, when the Swiss National Bank (SNB) removed the peg of 1.2 francs per euro. This was an unexpected decision that led to major movements in the currencies market. It also led to a few bankruptcies. If you have not put proper risk management tools like a trailing stop loss, this could lead to significant losses.

Swap charges

Most forex brokers charge a fee for all trades that are left trading overnight. These charges are known as swap charges. The swap charge is usually the interest rates differential between the two pairs that you are holding. While swap charges are relatively small, they can add up especially when you have multiple trades open for a few days.

Reversal Risks

Finally, there is a risk of a reversal before the price target is reached. For example, if you buy EUR/USD pair at 1.1200 and the set a price target at 1.1250. Your thesis can work right until when the price reaches 1.1245 and then it reverses. If you are watching the trade, you can close it and take the profit. If you are asleep, you will wake up to find an unwanted loss. This problem could be mitigated by having a trailing stop loss.

Final Thoughts

Swing trading is one of the most common trading strategies in the market. It is used by both individual traders and the most successful Wall Street traders. In this article, we looked at the top strategies that these traders use and the risks involved. If you are interested, we recommend that you first take time to read books and watch videos about it. We also recommend that you take a lot of time creating and refining your swing trading strategy. And back test it to see if it actually works.