Explanation of Swing Trading

Swing trading is a very popular trading style for all kinds of investors. It can be used when investing in a range of financial instruments in addition to options such as stocks, futures, and foreign currencies. It's essentially a style that is somewhere between the longer term approach of using a buy and hold strategy and the very short term style of day trading.

It's typically a style used by those relatively new to options trading, but it's also often favored by those with more experience too. There are a number of benefits to swing trading and in particular to using this style for trading options. As with any type of investment, there's a lot of information you should learn before actually getting started.

On this page we offer detailed information on exactly what is involved with swing trading and why it is a style that you should consider using. We have also offered some advice on implementing it. The following topics are covered:

  • What does Swing Trading Options Involve?
  • Why use a Swing Trading Style?
  • Advice for Swing Trading Options
  • Options Brokers for Swing Trading Options

What Does Swing Trading Involve?

Swing trading is all about looking for short term price momentum and trying to profit from that price momentum by buying and selling appropriately. As the value of options contracts is largely based on the value of underlying securities, you are essentially looking to identify the price momentum of any financial instrument, such as stocks, and then trade the relevant options contracts according to how you expect the underlying security to move.

Generally you will be entering a position and then exiting it a short period of time later. That period of time can be anywhere between a couple of days or a few weeks, depending on how long you are expecting the price momentum to last.

With this style, you aren't as concerned with the fundamental value of the securities involved and how they will perform in the long term as you would be using a buy and hold investment strategy. While some fundamental analysis of the securities can certainly be useful, you are basically looking to identify situations where any particular security is likely to move reasonably significantly in price over a relatively short period of time. This is based on patterns and trends. Once you have identified that situation then you can then buy or sell accordingly with a view to profiting from the price movements.

Swing trading can be done using most types of options, and you can use different orders to take long positions or short positions on specific contracts. You can even use a combination of different contracts and orders to create spreads which can greatly increase the number of opportunities for profiting. Spreads can also be used to limit risk exposure on a particular position by minimizing potential losses.

There are actually two different forms of swing trading options: mechanical and discretionary. Mechanical swing trading involves following a rigid set of rules to determine fixed entry points and exit points, and you can even use software to determine what transactions you should be making and when. Discretionary swing trading is based on using your own judgment and analysis to make decisions.

Why Use a Swing Trading Style?

Of the two most widely recognized trading styles, swing trading and using a buy to hold investment strategy, swing trading is by far the most suitable style for options. The buy to hold strategy isn't really suitable at all, because options are basically short term trading instruments. Most contracts expire after a few months or shorter, and even the longer term LEAPS usually expire after one year. As such, options are the perfect tool for swing trading.

Swing trading is a lot less intense than day trading and also a lot less time consuming. With day trading, you have to be prepared to spend the whole day monitoring the markets while waiting for the right time to enter and exit positions. The levels of concentration required can be very draining, and it requires a very specific skill set to be successful using this style. Swing trading, on the other hand, is a perfect middle ground for those that want to see a reasonably quick return on their money but don’t have the time to dedicate to buying and sell all day, every day.

It's a great style for those that are relative beginners and those that hold down full time jobs or have other time commitments during the working day. It's possible to highlight potential swings, enter the relevant position, and then just check how your position is faring at the end of each day, or even every couple of days, before deciding whether or not to exit that position.

You can set stop losses or use spreads so that you are never in danger of losing more money than you are comfortable with. You can actually use spreads in a variety of strategies, some of which are particularly useful for swing trading when you aren't permanently monitoring price changes in the market.

The basics of this style are relatively easy to get to grips with, which is another good reason for giving it a go. You don’t have to have a huge amount of knowledge to get started; you just need to know how options work and be prepared to dedicate a reasonable amount of time to looking for the right opportunities. There are inevitably certain risks involved, but this style largely enables you to take whatever level of risk that you are comfortable with and it still gives you the chance to make some decent profits.

Advice for Swing Trading Options

Planning and researching are very important for anyone looking to use this style. You should be well prepared and have a good idea of exactly what kinds of patterns and trends you are looking for and what sort of transactions you are going to make in any given situation. You do want there to be a certain amount of flexibility in the way you trade, but it can definitely help to have a clear set of objectives and a defined plan for how you will achieve those goals. The market can be unpredictable so you will need to be able to adjust accordingly. However a solid plan at least gives you a platform to work from.

Good analytical skills are very useful. You don’t have to make decisions as quickly as if you were day trading so you have the time to analyze situations and work out the best entry and exit points of any particular pattern or trend that you identify. It's also important to be patient. If you can't find a good entry point to take advantage of a price swing, then you need to have the discipline and patience to wait until an opportunity presents itself. You don’t need to be making trades every day if there are no suitable ones to be made, and the key to success is really all about choosing the right opportunities and executing your transactions at the right time.

It's a good idea to set maximum losses on any position that you enter. It's unlikely that you will get your predictions and forecasts right every time you enter a position, and sometimes the prices will move against you. You should always be prepared to cut your losses and get out of a bad position; it can and will happen and you just have to make sure that your good trades outweigh your bad trades.

Similarly, you should always have a target profit for a position, and close your position when you have made that profit. Trying to squeeze extra profit out of an open position can just as easily result in losing your profits. You can easily set your parameters for limiting losses and locking in profits by using stop orders, options spreads, or a combination of the both.

Options Brokers for Swing Trading Options

One of the most important decisions you need to make before starting out with this, or any other style, is which stock broker should you use? Using an online broker isn't as essential for swing trading as it is for day trading, but you could use a traditional broker if you wanted. However, there are still many advantages to using an online broker; for example they generally offer cheaper fees and commissions which will help you place your orders.

For further advice on this particular subject, we would suggest reading the following page: Choosing an Online Options Broker.