How Does Swing Trading Work?

Swing trading simply seeks to capture short-term gains over a short period (days or weeks) by attempting to capitalize on dramatic price movements in the underlying security. Swing traders might choose to go long or short the market to potentially capture price swings toward the upside or downside, or between technical levels of support and resistance. 

These four components are widely considered critical to a swing trade setup: 

• Which direction to trade—long or short
• Where to enter the market
• What price to take profits
• What price to cut losses 

In addition, traders must ask themselves why they're buying or selling at a specific price and why the trade's target levels make sense. Because the time constraints of these trades are tight, technical analysis is critical in swing trading. For example, if the underlying asset doesn't reach a specific price within a relatively specific window of time, a trader may want to close the trade. 

Although swing traders may use fundamental analysis—like economic cycles, earnings, and other longer-term trends—to provide perspective for their trade opportunities, most will use technical analysis tactics. 

Chart patterns that focus on a narrower time frame and price context might help traders identify specific entry points, exit points, profit targets, and stop order target levels. 

Given its focus on timing, swing trading as a strategy resides somewhere between so-called day trading and traditional long-term position trading or investing. But there are some key differences. 

Although swing trading and day trading both target short-term profits, they can differ significantly when it comes to duration, frequency, size of returns, and even analysis style. 

Day traders generally seek to get in and out of a trade within hours, minutes, and sometimes seconds, often making multiple trades within a single day. Because of the ultra-narrow time frame, day traders aim to capture smaller gains more frequently—unless they're trading a major news event or economic release, which can cause an asset to skyrocket or nosedive. 

Typically, day traders pay little attention to market fundamentals, which are unlikely to shift within a single day. Much of the seemingly "random walk" of prices from minute to minute may appear as noise to long-term traders, while day traders might consider these tradable fluctuations. And because fundamentals are likely not influencing these minute price shifts, day traders often rely on technical analysis to gauge these micro-movements of supply and demand. 

In contrast, swing traders attempt to target larger market swings within a more extended time frame and price range. Larger price action within a span of days or weeks can often be sensitive to investor response toward fundamental developments. Hence, swing traders rely on technical setups to execute a more fundamental-driven outlook. 

Here are a few common chart patterns swing traders may look for. For more detailed examples on swing trading entry and exit strategies, check out Joe Mazzola's "The Ins and Outs of a Swing Trade."  

A breakout from the bullish flag pattern is a classic setup for a swing trade. Here's a hypothetical example of what a swing trader might look for. 

• Stock ZYX rallied from $150 to $185 over the past three weeks, nearly a 25% gain.
• This breakout is accompanied by high volume.
• The increase is illustrated, from top to bottom, as the flagpole. 

• Stock ZYX consolidates between $185 and $168 over the next couple of weeks, retracing roughly half of its earlier gain. Traders might say this is the flag "flying at half-staff."
• Volume decreases during this time, which is a key characteristic of bull flags.
• The price movement forms a slightly declining channel. 

• Having watched this technical action, a trader enters the trade (1) when the stock is trading at $172 (above flag resistance) on increased volume.
• Price target B is $189.50, or half the flagpole length above the breakout point. The trader could take partial or full profits at this level.
• Price target A is $207, or the entire length of the flagpole.
• Stop level (C) is $167.50 (below flag support) for an estimated risk per share of $4.50. Reminder: A stop order will not guarantee an execution at or near the activation price The actual execution price may be significantly higher or lower. Once activated, stop orders compete with other incoming market orders. 

When bull flag trades work as intended—which is never guaranteed—the trader essentially enters the position as the underlying security takes a pause within a strong uptrend. By entering the trade at the breakout from the flag formation, the trader targets continued upward momentum while also having a protective stop order in place to help manage some of the downside risk should the stock price fall. 

While not as narrowly focused as the day-trading strategy, swing trading also differs from long-term position trading. Position traders, not unlike investors, may hold a security for weeks, months, or even years. This longer-term outlook may also change the nature of how they conduct their initial analysis. 

Because position traders look at the market's long-term trajectory, they may base their trading decisions on a more expansive view of the fundamental environment, aiming to see the big picture and capture potential returns that may result from correctly forecasting the large-scale context. 

The longer the time horizon, the more prices swing within the trajectory. A position trader might hold through many smaller rallies or pullbacks, while a swing trader would likely consider trading them. 

Some traders might use swing trading strategies to try to supplement or enhance a longer-term investment strategy. It's one of the few ways traders can attempt to capture frequent short-term price movements in a market landscape that tends to evolve at a much slower pace.

Those beginning to experiment with swing trading should be mindful of two key risks and may wish to be conservative with the capital dedicated to this trading style. 

Trading frequency: By definition, short-term trading opportunities can occur more frequently than their longer-term counterparts, but more frequent trading brings more frequent risk exposure and more transaction costs. Unless a trader understands and can confidently manage the risks and costs that come with higher trading frequency or volume, they might want to start slowly. 

Trading complexity: Because every trading opportunity can present a unique market scenario, a swing trader's approach can vary considerably, which adds complexity. The greater the complexity, the greater the risk of misreading the market or making mistakes executing on their strategy. 

Swing trading is a specialized skill. It isn't for every trader, and not every trader can succeed at it. It takes time, practice, and experience to trade price swings.

As the saying goes: It's one thing to know what a chart is. It's another to know how to read it effectively. 

Those with a low risk tolerance or lacking sufficient risk capital might want to avoid the strategy altogether. Others may find it a valuable skill that could potentially supplement longer-term investments. The right combination is different for every trader, so it's important to start with the basics of technical analysis and transition to using indicators and patterns that make the most sense.