Stock Selection: The Most Essential Criteria when Picking Stocks for Swing Trading
Before analyzing any price chart, you first must ensure that the stock is suitable for your trading strategy. Stocks are not all the same. They don’t all exhibit the same behavior nor set of patterns. The best stocks for swing trading are typically those that exhibit 3 core traits: high liquidity, healthy volatility, and an identifiable trend.
- High Liquidity: Liquidity refers to how easily a stock can be bought or sold without causing a major shift in price. For a swing trader, high liquidity is non-negotiable. It ensures you’ll be able to enter and exit positions quickly and without issues. Low-liquidity assets usually come with wide bid-ask spreads, which is a hidden cost that can lead to slippage, where you get a much worse price than you first intended to. To assess whether a stock is easy to buy or sell, look for stocks with an average daily trading volume of at least 500,000 shares. Preferably with over 1 million.
- Healthy Volatility: Volatility is what drives profits in swing trading. A stock that doesn’t move will hardly provide chances for swing trading success. We need significant price movements to make money. You must be cautions, though, and consider that, although too little volatility means fewer opportunities, excessive volatility makes price movements extremely erratic and unpredictable. When volatility is too high, risk management becomes nearly impossible. One of the most useful indicators for measuring volatility is the Average True Range, or ATR, used by many professional traders for stock picking.
- Identifiable Trend: Swing traders often achieve their best results when they trade in the direction of a prevailing trend. A stock in a clear uptrend or downtrend provides a path of least resistance. Fighting the trend is like swimming against a strong current. Although possible, It is unnecessarily difficult. Your goal is to identify a strong and established trend and ride its momentum for a short period.
Overall, large-cap and mid-cap are the types of stocks most suitable for swing trading, because they offer the ideal combination of technical analysis behavior and healthy volatility.
Setting Up a Screener to Identify Stocks
A stock screener allows you to apply custom filters to the market. These filters block out the noise and reduces the number of potential stocks to a more manageable list of candidates that meet your criteria. This is your watchlist.
The process of building a watchlist can broken down into 2 main steps:
Step 1: Descriptive Filters
In this initial step, you will select only the most robust and healthy set of stocks. Your focus is on finding assets that are easy to trade.
- Market Cap: Set to > $2 Billion. Focus on mid-cap and large-cap companies. They offer more stability and liquidity, on average.
- Average Volume: Set to > 1 Million. This is your primary liquidity filter. This will help you get in and out of trades without major problems.
- Price: Set to > $10. Avoid speculative penny stocks, they often behave too erratically.
Step 2: Technical Filters
Now that you have a list of “tradable” stocks, you can apply technical filters to find the ones with a more promising setup.
- Trend Filter: A simple, yet powerful, filter is setting the price to be above the 50-day simple moving average. This narrows your search to stocks that are in a medium-term uptrend.
- Momentum Filter: Use the Relative Strength Index, RSI, and set the range to be between 40 and 70. This helps you find stocks with positive momentum that are not yet overbought.
Note that your screener is not yet a buy list. It instead behaves as a list of candidates that still require further analysis before the next step is taken. Ideally, you will want to visually inspect the chart of each stock to see if a trade setup exists, identify entry and exit points, and identify your stop-loss zones.
Using Technical Indicators when Swing Trading Stocks
Technical indicators are tools that help you read price action and confirm your trading thesis. A common mistake beginners make is filling up charts with dozens of indicators. Instead, focus on a simple trio that covers trend, momentum, and trend shifts.
- Moving Averages: A moving average shows the average price of a stock over a specific period. It smoothes out noise and highlights the trend. For swing trading, the 20-day and 50-day moving averages are highly important. When price is above these key MAs and they’re pointed upwards, it serves as a confirmation of a bullish trend. These levels also work as dynamic support zones, providing areas to look for a pullback entry.
- Relative Strength Index: The RSI is a momentum oscillator that measures the speed and magnitude of price movements on a scale of 0 to 100. Overall, a stock is overbought when RSI > 70 and it is oversold when RSI < 30. Although it’s easy to identify overbought and oversold levels, you should be aware that a stock can remain under the extremes for extended periods, especially in strong trends. Trying to hit the reversal price by opening a position against the predominant trend is extremely risky and can lead to bad results.
- Moving Average Convergence Divergence: The MACD is a trend-following momentum indicator that displays the relationship between two moving averages. One of the most relevant setup is the bullish crossover, where the MACD line crosses above the signal line, and indicates that momentum is shifting to the upside.
Although the ones above are among the very best indicators for swing trading, you must always confirm your analysis with trading volume. A breakout above a key resistance level, for example, is always more credible when accompanied by high volume. Volume = conviction.
Multi-Timeframe Analysis: One of the Best Swing Trading Strategies
One of the best swing trading strategies you can employ is multi-timeframe analysis. This is done by looking at the same stock on different chart periods to gain a more complete view of its behavior, momentum, and trend. It helps you avoid making a decision that might look good on the short-term, but terrible in the face of the long-term trend.
Here’s how it works:
- Evaluate the Long-Term Trend (Monthly/Weekly Chart): This timeframe is used to confirm the predominant trend. If the weekly chart is in a strong uptrend, you should only be looking for opportunities to go long, buy stocks.
- The Trade Setup (Daily/4-Hour Chart): This is where you identify the specific setup behind your trading thesis (pullback; consolidation; etc.).
- The Entry Trigger (4-Hour/1-Hour Chart): This is your execution timeframe, where you pinpoint your entry, such as when the price breaks above a certain resistance from a small consolidation (e.g., flag pattern) or pulls back from a relevant MA. This helps you refine your entry and exit points for better precision.
Key Events
Some key events can cause a sudden and sharp movements in price, both bullish or bearish. Although these events can create opportunities for going long or short, they also come with elevated levels of risk.
Quarterly earnings reports are among some of the most important events that drive stocks prices. Shares can move dramatically based on whether a company meets, beats, or misses expectations. It is noteworthy, however, that market reaction is more often than not unpredictable. Holding a position through an earnings announcement is a high-risk gamble. Most professional swing traders prefer to close their positions before an earnings date to avoid this unnecessary exposure.
Other important events include major news, product launches, regulatory updates, and economic data releases. Always be aware of the upcoming key dates for any of the stocks you are watching.
A Lesson in Risk Management: When to Avoid Entering a Position
Just as important as knowing when to enter a trade is knowing when to stay away. Preserving capital by avoiding low-probability setups is how you survive in the long term.
When it comes to breakout trading, for example, it is essential to use volume to assess market sentiment. Low-volume breakouts implies a lack of conviction and are prone to false signals. It is always good to stay out of the market when such a chart pattern arises.
Chasing entries after missing the most optimal entry is also a setup for failure. This leads to bad risk-reward ratios and rarely offers a better outcome than simply waiting for the next setup.
How to Manage Your Watchlist
Your watchlist is a dynamic tool that you use to organize high-quality stocks for swing trading. It keeps you focused on finding stocks with high probability trading setups. In order to effectively manage your watchlist, you must:
- Keep it Small: An oversized watchlist is a recipe to analysis paralysis. A small list of 10-20 high-quality stocks is far more effective than a large list.
- Categorize Your Watchlist: Segregate your watchlist into different groups. You can have one main category for initial ideas, and another prime group for stocks that are closer to an entry trigger.
- Review It Regularly: Don’t forget that markets change fast. It is essential to review your list weekly. Remove stocks that have broken their trend and run your screens again to find new candidates.
Adapting Criteria to Capital Size
The core criteria to selecting the right stocks for swing trading remain the same, regardless of account size. Liquidity, volatility, and trend.
Your capital size does influence your constraints, however. When it comes to risk management, a golden rule is to never risk more than 2% of your entire trading account on a single trade. With that rule, some high-price stocks may end up being impractical, due to how unrealistic it becomes to set stop-loss orders. Traders with smaller capital may need to add a maximum price filter to their screens to focus on stocks where proper position sizing is more feasible and profitable.
