Swing trading is a technical discipline. Although no hard-and-fast rule defines it, swing traders often trade in 100-share increments and usually limit the number of simultaneous positions to ten or fewer. A swing trade can last for as little as a few hours to as long as a few weeks, but typical swing trades span no more than a few days.
On this kind of time scale, fundamental analysis has little impact on a stock’s price movement; therefore, stock selections are made using technical-analysis tools. Careful trade management is crucial to swing-trading success.
Stock selection is even more important for swing trading than it is for position trading. When you’re looking for a stock to move right away, you base your decisions on selection criteria that are different from when you’re positioning for a move that may last for several weeks to several months. Following are a few of the important selection criteria that swing traders use:
Volume and liquidity: Swing traders typically focus on actively traded and relatively large stocks. The goal is finding stocks that are easy to buy, sell, and sell short. When trading time frames are short, you need to be able to execute your orders quickly.
Unfortunately, stocks with the greatest liquidity and trading volumes are closely followed by the largest number of professional traders, which usually constrains the number of profitable swing-trading opportunities, so swing traders often scout opportunities outside of the 25 or so stocks that have the highest trading volume and greatest liquidity.
Trending: Trending stocks provide the best opportunity for swing-trading profits. You may either use the methouse the average directional index (ADX) indicator. This indicator has three components: the ADX reading and two directional movement indicators — the +DMI and the –DMI. An ADX reading of more than 30 or so indicates a trending stock.
A comparison of the two DMIs shows you whether the ADX is trending up or down. If the value of +DMI is larger than the value of –DMI, then the stock is trending higher. If the value of –DMI is larger than the value of +DMI, the stock is trending lower. The ADX indicator is included in most charting applications.
Volatility: Swing traders depend on larger, or more volatile, short-term moves for profits. As a result, they want to trade stocks that have histories of making large moves in short periods of time.
One popular approach to finding them is keeping an eye on the average daily ranges (ADRs), which are simple moving averages that track the day-to-day differences between an individual stock’s daily high and low prices. If you’re swing trading, you want stocks that show high ADRs. Volatility also can be measured using historic volatility.
Sector selection: Just like position trading, swing traders try to trade stocks in the strongest sectors, and the weakest sectors are candidates for short sales.
Tight spreads: As a means of controlling slippage, you need to pay close attention to the difference between the bid and ask prices of the stocks you’re considering as swing-trading prospects. Stocks with wide spreads make profitable swing trading difficult. Low-priced stocks rarely are good candidates for swing trading because the spread, as a percentage of the stock price, is usually too wide.