When it comes to the financial markets, there are three main ways in which participants make money. Long term traders like Warren Buffett and Daniel Loeb buy stocks and hold them for decades. Day traders on the other hand buy securities and exit them within the same day while swing traders exit their trades within a few days. It is possible to make money with either method but below is an array of swing trading strategies.
This is a swing trading strategy where traders focus on buying securities. When they buy, their hope is that the price of the security will move higher. For example, when the EUR/USD pair is trading at 1.1210, a long only trader will place a buy trade hoping that the price will gain within a few days. Their goal is to find oversold opportunities and identify when a trend is emerging. They then place the buy trades and wait for the price to move up.
To identify the formation of a trend, the traders use a combination of fundamental analysis and technical analysis. For example, if the EUR/USD tends to move higher two days before the release of Non-Farm Payrolls, the trader can initiate a buy trade. With regards to technical analysis, traders use indicators to identify bullish signs which are then confirmed by oscillators like the Relative Strength Index (RSI). The most commonly used indicator for identifying the formation of a trend is the Average Directional Index (ADX).
Short only swing traders focus on finding overvalued or overbought securities and initiating trades that will benefit as the price moves lower. They follow a similar strategy with the long only traders with the only difference being the direction they hope for.
In stocks trading, short-only traders expose themselves to more risks than long-only traders. This is because in long only trades, the lowest level a security can reach is $0 and therefore, this is the maximum loss that a trader can make. For short-only traders, they benefit when the price of the asset goes low and lose when the price goes higher. Therefore, since a security does not have a limit to how high it can go, the trader’s losses can be infinite. When this happens, it is known as a short squeeze.
This is the most common swing trading strategy. With this, traders buy securities they believe will go up and sell the securities they believe will move down. The analysis used in this strategy is the same, but traders need to be careful. In a long-short strategy, it is possible to open trades that don’t necessarily work well. For example, a trader can open a trade to buy EUR/USD and another one to sell the EUR/GBP. While the two trades could be profitable, they are risky because the trader does not have a common ground on the euro. In the former trade, the trader hopes that the euro will strengthen while in the latter, the trader hopes that the euro will weaken. As such, understanding the concept of correlation is very important when using the long-short strategy in swing trading.
Arbitrage is another strategy that swing traders use, mostly to hedge against adverse events in the market. In this strategy, a trader opens two trades in the opposite direction. The hope in arbitrage is that when the real trade goes in the opposite direction, the other trade will help reduce the impacts of the loss.
There are a few ways swing traders can use the arbitrage strategy. Merger arbitrage is ideal for CFD traders. In merger arbitrage, traders open trades based on the news of mergers and acquisitions. When a company announces that it will acquire another company, an arbitrage opportunity emerges. Historically, shortly after the deal is announced, the stock of the acquiring company tends to fall while that of the company being acquired rises. In this case, a trader can buy the stock CFD of the company being acquired while shorting that of an acquirer.
Still, the reverse can also be done—buying the acquirer and shorting the buyer—if the trader believes that the deal will be rejected by regulators.
Another arbitrage strategy used by traders is the triangle arbitrage. The triangular arbitrage strategy is also known as the three-point arbitrage and is used to exploit the opportunity that results from the pricing of three currency pairs. In it, you exchange the first currency for the second, the second for the third, and the third currency for the initial. In the second trade, the trader locks in a zero-risk gain from the mispricing in the market when the market price is not aligned with the implicit cross exchange rate. For example, if the EUR/USD pair is trading at 1.2500 and the GBP/USD pair is trading at 1.3500, the implied value of the EUR/GBP pair is 0.9259 (1.2500/1.3500). Therefore, it is possible to do a triangular arbitrage by buying the EUR/USD pair, selling EUR/GBP, and selling the GBP/USD pair.
Another arbitrage strategy is the statistical arbitrage. In this, a trader can form a basket of oversold currencies and another basket of overbought currencies. Then, the trader buys the oversold currencies and sells the overbought currency pairs. Swing traders believe that even in long-term bull and bear markets, securities make several short-term pullbacks. Using the statistical arbitrage strategy, traders benefit from these short-term movements.
It is essential to understand how arbitrage strategy works, however, while OctaFX allows traders to use all trading strategies, arbitrage trading is an exception, as its use is prohibited by Customer Agreement.
This is a relatively new swing trading strategy where traders create algorithms which initiate trades when certain parameters are reached. The parameters are built based on the technical indicators that the trader uses. For new traders without any background in programming, this strategy is not recommended.
While these are the most common swing trading strategies, you can create your own personalised strategies for swing trading. Before using the strategy, you can try it out with the strategy tester found in the MetaTrader platform offered by OctaFX. Also, you should understand the overnight costs and swaps offered by the broker.