The chart below shows a price chart in a downtrend, with the swing highs and swing lows highlighted.
In an uptrend, a trader would be looking to buy, or 'go long', from these lows to the highs.
In a downtrend, traders would be looking to sell, or 'go short', from the highs to the lows.
It is impossible to consistently pinpoint the exact high and low of every swing move, but the idea is to capture as much of the price movement as possible. In fact, it’s common to miss the exact highs and lows, as it can take time to confirm that a new swing is underway.
Let’s look at a swing trading example in an uptrend and a swing trading example in a downtrend.
In essence, this type of trading involves identifying short-term trends. If the trend is up, you 'buy the dips' and if the trend is down you consider 'selling the rallies'.
Building a swing trading strategy
Before you open your first position, it’s important to build a swing trading strategy that you have confidence in. As swing trading is based on identifying points where the market is changing direction, you will need to establish a methodology for entering and exiting trades, as well as a risk management strategy to minimise losses if the market moves against your prediction.
Using technical indicators for swing trading
Many traders will use charts and technical indicators to try and identify swings in markets, and profitable entry points.
One of the most popular indicators to use is the moving average. In principle, when the price is trading firmly above the moving average the trend is considered to be up and when the price is trading below the moving average the trend is considered to be down.
Once a trend is identified, a trader could consider using a momentum indicator in an attempt to try to capture swings in the overall trend.
Popular momentum-type indicators are often referred to as oscillators, and two of the most popular are the stochastic and the Relative Strength Index (RSI).
In an uptrend, a move out of oversold territory as indicated by the RSI (highlighted on the chart below) might be a signal to buy a trade (take a long position). An overbought signal may be a signal to exit the trade.
In a downtrend, a move out of overbought territory (highlighted on the chart below) might be a signal to enter a short trade (sell), while an oversold signal may be a signal to exit the short trade and not trade against the trend.
Managing your swing trading risk
As swing trading is based on a market changing direction, it is important to have measures in place to prevent unnecessary losses and manage your risk.
Traders taking long positions might consider placing a stop loss, an order to sell at a specific price to limit potential losses, at the point where they think the short-term swing trend has started, for instance, the swing low. If the swing low were to be broken and a new low formed, that’s a logical place to admit the failure of the uptrend assumption and trade.
Traders taking short positions might consider placing a stop loss around the level of the swing high. Again, if the price moves back above the swing high, going on to form a new high, then it’s logical to admit the failure of the downtrend assumption and trade.