Trading without an edge is gambling. One of the market systems that has consistently provided an edge is momentum. The basic premise of momentum is: stocks that have outperformed in the past six months and have just broken out to new 52-week highs, are likely to continue to outperform in the next six months. People who utilise the concept of momentum approach the market in two major ways:
1. Position trading – hunt for several huge winners in a year. Build large positions in them and ride them for big opportunities.
2. Swing trading – hunt for hundreds of 5-20% short-term winners, where the goal is to compound capital quickly by actively moving in and out of them.
There is no right or wrong approach here. Both can have a place in the arsenal of a market participant.
Everyone can buy a stock with a huge potential, but not everyone can hold it long enough to make a difference in their returns. Most investors are wired to sell their winners quickly, which prevents them from catching big stock market gainers.
Any decision you make in the market comes at a price. If you sell all your winners, when they are up 20% you will never catch a double or a triple.
If you want to catch a 100-200% long-term winner, you have to be willing to sit through multiple consolidations and several bigger than 20% pullbacks.
But not everyone has the stomach to ride big stock market gainers. The drawdowns of position trading and trend following are too scary for most. Swing trading offers an alternative way to achieve significant returns, but with a lot smaller drawdown.
Swing trading is, in my opinion, among the fastest way to grow capital. Its aim is to stay in stocks that are moving quickly in your favour and avoid “dead money” periods. Most stocks tend to move in 5-20% momentum bursts that last between two and 10 days before they mean-revert or go into sideways consolidation.
The goal of every swing trader is to capture a portion of a short-term momentum burst while avoiding consolidation periods. Then to repeat the same process hundreds of times in the year by risking between 0.5% and 1% of capital per idea. Small gains can compound quickly.
The beauty of swing trading is that it provides many signals. In any given year, there are a lot more 10-20% moves than 100% ones that you can capture. You don’t need to risk a lot per signal, which means you won’t second-guess yourself on whether to take a signal or not. One trade is not going to make your year or your month, but it also won’t ruin it.
Swing trading relies on the magic of compounding. The idea is to grow capital quickly by being leveraged to the hill during strong market uptrends and being mostly in cash during choppy and highly volatile markets.
Bio: Ivaylo Ivanov is the founder of MarketWisdom.com and the author of Amazon bestsellers Top 10 Trading Setups – How to Find Them, How to Trade Them, How to Make Money with Them, and The Five Secrets to Highly Profitable Swing Trading.