Swing trading is a technical, rules-based approach to trading which is suitable across multiple markets and timeframes, either with or against the trend. Carrying on from our series of different trading styles we’ll take take a more in-depth view of this approach to the markets.
What is Swing Trading?
Whilst there are many explanations on this trading style, swing trading has no fixed definition as it can overlap with many other trading styles. But we can say its most defining feature is where, within the cycle of a trend, a trader aims to enter a trade.
Swing traders essentially take advantage of the fact that “markets do not move in a straight line” and try to capture the moment the pendulum swings to take a market in the opposite direction. In the above illustration we have depicted a bullish trend as a perfectly rising sine wave. A trend trader aims to identify a trend and stay with it for as long as possible, whilst riding out the fluctuations of the evolving trend. Yet a swing trader would try to capture the moves in between the interconnecting peaks and troughs. This means there will be times that the swing trader will be aligned with the dominant trend, and others will be trading against it, depending on whether their swing trading system is trend following or counter-trend based.
Therefore the trick to swing trading, if there is such a thing, is identifying the swings as soon as possible whilst filtering out weaker signals.
A Basic Approach to Building a Swing Trading Strategy
Swing trading is generally a mechanical, rules-based approach to trading price fluctuations. Throughout the article we will discuss the elements traders can combine to create their own swing trading system. But first we’ll show some basic questions a trader can ask themselves to form a foundation for a swing trading strategy.
- What is the desired hold time / timeframe to enter?
- Which market/s asset classes will be selected?
- Will it be a trend following or mean reversion strategy?
- How will the trend be defined? (eg. price action, indicators / which indicators?)
- How will the swing be identified? (eg. pivots, candles, indicators?)
- Which filters can be applied to identify higher probability swings?
Which timeframes are suitable for swing trading?
Whilst there is no fixed timeframe for a swing trader, a typical entry timeframe for a swing trader would either on the daily chart (D1), 4-hour chart (H4) or hourly chart (H1). But that is not to say swing trading systems cannot be used on lower timeframes such as the 15-minute (M15) or higher timeframes such as the weekly chart (W1).
Those entering on the daily chart would usually be an EOD trader looking to hold for a few days to a few weeks. Whilst those entering on the H1 or M15 minute charts are more likely to be day traders, although hourly charts could allow for a trade to be held for a couple of days or more, depending on the market.
Which markets are preferrable for swing trading?
Ultimately, any market which oscillates enough with bursts of volatility can be considered for swing trading. But each asset class has their own set of features and volatility levels which may impact the timeframe or method to approach that market.
With FX being so highly liquid, it means the market is far more efficient which can at times suppress volatility when directly compared with other markets. This usually means that forex cross pairs make better swing trading candidates than major FX pairs, because they are generally more volatile.
However, if the chosen FX pair does not seem to offer the desired reward to risk potential on the daily chart, the trader could refer to lower timeframes such as the H4, H1 or the M15 charts. In doing so it may increase potential swing signals.
FX pairs to consider for swing trading:
Indices such as the S&P 500 (US500), DJIA (US30) and Nasdaq 100 (USTEC) have been a popular choice for swing traders on the D1, H1 and M15 charts. That said, there have been periods of time where they have effectively moved upwards in a straight line since QE (quantitative easing) was introduced. This can be frustrating for a swing trader who is looking to enter, as pullbacks rarely present themselves. On the flip side, those who were lucky to get into a trade early on have less work to do if the market continues to move in their favour. But also less opportunities to re-enter. That said, if daily volatility is low, then it can help to refer to an intraday timeframe to increase the frequency of potential opportunities.
Due to their higher levels of volatility, commodity markets have historically been a popular choice for swing traders. In fact, one of the earliest proponents to swing trading was a commodities trader in the early 1900’s called WD Gann.
Some commodities such as orange juice (OJUSD) and corn (CORN) have strong seasonal cycles they are popular for longer-term swing trades that can last weeks to months. And precious metals such as Gold (XAU/USD) and Silver (XAG/USD) also following seasonal patterns throughout the year. Energy commodities such as oil (WTI, Brent) are also sensitive to geopolitical events which can bring significantly large moves for intraday traders.
Overall though, day to day levels of volatility are generally higher than indices or forex pairs on a relative basis.
If traders seek volatility then crypto currencies are an obvious choice. Bitcoin (BTCUSD) is typically the most volatile of them all, followed by Ethereum (ETHUSD) and Ripple (XRPUSD). However, the trader should be aware of margin requirements and levels of volatility for any market they trade, to help minimise the risk of losing their trading account.
Elements to Build a Swing Trading System
Swings / Pivots:
Not to be confused with pivot points, a ‘pivot’ is a mechanical way to help identify a swing low or a swing high. Whilst there are various way to go about this by combining closing prices in relation to highs and lows, a typical approach is as follows:
- Bullish pivot (swing low): Bar-1 low is above bar-2 low, bar-3 low is above bar-2 low
- Swing high (bearish pivot): Bar 1-high is beneath bar-2 high, bar 3 high is beneath bar-2 high
However, a major drawback of using pivots alone is they will generate many false signals during choppy trading conditions. And if the above example were to be used ‘as is’ to identify swings, it can generate bullish and bearish signals on consecutive bars. Therefor a trader may want to experiment with pivots to use more bars either side of the perceived swing, and introduce more relationships between the relevant high, lows and closing prices. Moreover, a pivot can be combined indicators, trend analysis and support and resistance levels in order to filter higher probability turning points.
Candlestick Reversal Patterns:
Candlestick reversal patterns are a good way to highlight potential swings although, like pivots, they can also provide too many signals during choppy trading conditions. But once filtered with some of the indicators below, a simple rules-based trading process can begin to take shape. On EUR/USD we have highlighted just some of the reversal patterns that formed near price extremes.
Popular Japanese Candlestick reversal patterns:
- Morning / Evening star reversals
- Bullish piecing line / dark cloud cover
- Key reversals
- Bullish / bearish engulfing candles
- Bullish / bearish outside bars
- Bullish / bearish hammers and pinbars
Moving Averages (MA’s):
As MA’s smooth out price action they can be used to identify trends and aid with swing trading. A common approach is to use a longer average, such as the 50 or 100-period MA to define a bullish trend. If price action is above the MA the trend is assumed to be bullish, whilst if prices are below the average the trend is assumed to be bearish.
Once the trend is established, swing traders can use retracements towards faster MA’s to seek potential swings that reverse and realign momentum with the dominant trend.
In this example, the criteria to highlight a swing was as follows:
- Prices must be below the 50-bar eMA
- 10-bar eMA < 20-bar eMA, 20-bar eMA < 50-bar eMA
- Prices have retraced towards the 10 and 20-day eMA’s
- A bearish reversal candlestick pattern must form around the 10 and 20-bar eMA’s
We can see that this system did a reasonably good job of filtering out many other candlestick patterns and staying with the trend. However, using moving averages for trend definition is not fool proof. We can see how prices whipsawed above all three averages between March and May 2020, which shows the danger of relying on moving averages for trend. This is why it is beneficial to use price action to identify trends as this would have kept the trader out of the market until the trend was fully confirmed. But for quick reference, MA’s do have their uses and can form the basis of an automated trading system.
The Zig Zag Indicator:
This indicator filters price action to only highlight a swings once prices have reversed by a pre-defined threshold. It’s a useful alternative and compliment to moving averages as it can help better define the swings, and is not as reactive as candlesticks or pivots.
Here we have overlaid two separate zig zag indicators with different settings, to show how the amount of swings can vary between them. Obviously, a faster a setting will generate more signals than the slower one, but presumably increases the odds of a weaker signal. With some experimentation of the settings, the trader may be able to come up with a threshold that fits their desired hold time and reward to risk in mind.
The advantage of the zig zag indicator over a moving average is that it can be more objective and factors in a level of volatility for the market. However, as appealing this looks on historical price action at pinpointing the swings, it must be remembered that price action has to move by a certain threshold before the latest ‘zig or zag’ is drawn onto the chart, so it is a lagging indicator in that respect.
DPO (Detrended Price Oscillator):
The DPO simply measures the distance between closing price and a moving average, then plots it as an indicator beneath the price chart. It can be a useful tool to highlight price extremes and visually quantify whether price action may be over-extended relative to its moving average.
In this example, we have overlaid a 14-period sMA (simple moving average) with a 14-period DPO. What becomes apparent is that over this period, the DPO created its own overbought and oversold levels which preceded price reversals.
The main drawback with this indicator is that, being an unbounded indicator, overbought and oversold levels are variable over time. And being a momentum indicator, it suffers from providing poor signals during strong trends. This is why it is always important to use price action to confirm a signal generated by an indicator.
As pivot points aim to provide future support and resistance, they are a valuable tool for many styles of trading. As they can be used on intraday, daily, weekly and monthly charts, they are especially useful for swing traders.
Refer to our guide on pivot points for further details.
In this example we have layered together a zig zag indicator with monthly pivot points on the H4 chart as part of a basic system. The trader could experiment with a faster zig zag setting or introduce candlestick patterns and oscillators for a more mechanical approach.
Bollinger Bands introduce a statistical element to technical analysis using standard deviation above and below an average. As they can behave as overbought and oversold levels, they are a popular tool to use alongside divergences to highlight a potential turning point. Add candlesticks into the mix and it may provide an extra filter on a market which provides too many signals.
Refer to our indepth guide on Bollinger Bands for further details
In this example, a stochastic oscillator has been used to identify divergences that appear in the overbought or oversold area whilst prices are near the upper or lower Bollinger Band. Candlesticks can also be used to fine tune the signal.
- Swing traders aim to enter the market at the turning point between peaks and troughs.
- It is applicable to trend and counter-trend traders.
- Swing trading can be a rules-based approach which blends the use of reversal patterns and indicators.
- Through experimentation, the following elements can be combined and changed to form the basis of a bespoke trading strategy.
- Pivots / swings
- Reversal candlestick patterns
- Moving averages
- Zig Zag Indicator
- Momentum indicators / oscillators
- Pivot points