Mastering ETF Swing Trading: Strategies and Tips

ETF (Exchange-Traded Funds) swing trading stands out as an interesting strategy, especially for those who understand the nuances of the ETF market. Despite the generally low success rate in trading, ETFs offer an opportunity for the interested trader. With a market size larger than the combined GDPs of economies like Germany and France, ETFs command over eight trillion dollars in global investments, showing their significance in the financial landscape.

What Are Exchange-Traded Funds?

With swing trading, Exchange-Traded Funds (ETFs) stand out as a versatile and easily accessible instrument, but what exactly are they? At their core, ETFs are investment funds traded on stock exchanges, much like stocks. They encompass a variety of assets, such as stocks, commodities, or bonds, offering traders a diversified portfolio within a single trade.

Scale and Impact of ETFs in the Global Market

The ETF market is not just significant; it’s massive. With over $8 trillion invested globally, ETFs have surpassed the combined GDPs of economic giants like Germany and France. This figure highlights the wide acceptance and reliance on ETFs in the financial world. The United States leads in ETF investments, followed closely by Europe and the Asia-Pacific region.

Daily Trading Volumes: Testament to ETF Popularity

The liquidity of ETFs is evident in their daily trading volumes. On average, equity ETFs see about $176.9 billion traded daily, while fixed-income ETFs account for around $32 billion. In 2022 alone, a total of $53.8 trillion worth of ETFs exchanged hands. These numbers not only reflect the high liquidity of ETFs but also underscore their importance in the financial markets.

Expense Ratios and Liquidity: Cost-Effective Nature of ETFs

One of the appealing aspects of ETFs is their cost efficiency. Generally, ETFs maintain low management expenses, making them an attractive option for traders who are mindful of costs. However, it’s crucial to recognize that not all ETFs are created equal in terms of fees and liquidity. While many offer low expense ratios and high liquidity, some may not align with these characteristics, necessitating careful selection by traders.

Leading Providers in the ETF Market

When it comes to ETF providers, a few key players dominate the market:

• BlackRock: With an impressive AUM of $2,329.43 billion spread across 432 funds.
• Vanguard: Managing $2,124.46 billion in assets and offering 82 distinct funds.
• State Street: Overseeing $1,055.54 billion in AUM with 138 funds.
• Invesco: Holding $403.58 billion in assets across 219 funds.
• Charles Schwab: With $286.37 billion in AUM and a portfolio of 30 funds.

These providers not only contribute significantly to the ETF market’s size but also influence the variety and quality of ETFs available to traders.

What Is Swing Trading?

Swing trading is a style of trading that aims to capture gains in an instrument over a period of days. Unlike day traders who exit their positions by the end of the trading day, swing traders hold their positions for several days to take advantage of short-term price fluctuations.

The goal of swing trading is to trade with the trend and the current swing but exit before the price reverses against the trader. Compare that to a day trader who looks to exit their position by the end of the trading day.  For a more extreme example, think of a scalper who lives in a world of seconds to minutes inside short-term price swings.

Successful traders need to have a good understanding of technical analysis and the overall trend of the markets, although trading against the trend is not always avoided.

If you are looking to use an ETF as part of a long-term buy-and-hold strategy, that is also possible.

Technical analysis is commonly used to identify support and resistance levels, as well as trends, and traders can use indicators, price action, and chart patterns to find trading opportunities. Tutorials on technical analysis are available on our blog to help traders determine their approach to the market.

ETF Swing Trading Strategies

There are many strategies that traders use for ETF trading and they can be broadly grouped into three main categories:

• mean-reversion
• breakout trading
• momentum trading

Trading an ETF is no different in terms of approach than swing trading stock or any other instrument and that includes risk and trade management.

Mean Reversion Strategy

This trading method is based on the idea that an instrument tends to cluster around an average price, known as the mean value. When the price moves too far away from the mean, it may make exaggerated moves in either direction before attempting to correct back to the average price.

By using a mean reversion strategy, swing traders can capitalize on these exaggerated moves and make profitable trades. It’s important to note, however, that this ETF strategy requires careful analysis of price movements as many mean reversions that take place on the price chart, are short-lived.

This is the XLK technology ETF with an overlay of the 20-period simple moving average. I have highlighted some areas where price interacted with the moving average. If you trade a price decline in the ETF back to an average price, you don’t want to short all moves to the upside.  A trader will want to find a large move, unlike a recent move in the recent past.

One approach is to use large range candles, Turtle Soup strategy, or bring up a Keltner Channel with the default settings onto your price charts.

While we have smaller runs into the upper channel as noted by the circles (and you could certainly trade those short), the one on the right is more interesting. You can see the price has been driven to new highs with multiple closes outside the channel. A trend line break or price reclaiming the former resistance level could be an entry for a short.

Breakout Strategy

Swing trading ETFs can also involve a strategy known as a breakout strategy. The idea behind this strategy is to enter into a trade when the price breaks above a resistance level or below support.

This usually occurs when there is a surge in buying pressure in the market, which can drive prices higher. Some traders may also monitor trading volume to confirm the breakout. To use this strategy effectively, it is important to identify when the price is about to break out. This can be achieved by analyzing past market data and looking for well-defined trading ranges.

Looking for a volatility contraction, a level of activity where the range of price gets tighter, indicating an anticipated breakout, is a great approach. Once the trader anticipates a breakout, they can enter into a long position in the ETF at the breakout price.

This chart uses the Bollinger Band Squeeze strategy where we look to see the bands inside the Keltner Channel.

At the black arrows, the blue BB lines are inside the black channel lines. This shows us a compression in the volatility. Also, note with the black lines, we get a triangle chart pattern that shows us lower highs but higher lows – a compressing of volatility.

You can read this post on the triangle chart pattern to learn more about a chart pattern breakout but essentially, look to trade the break of resistance.

If the price continues to move higher as expected, the trader can then exit the trade with a profit when price movement begins to stall. However, if the price reverses and starts to move back down, the trader can exit the trade to avoid losses.

There are other ways to trade breakouts but the squeeze as shown is a method to consider. You will need to define your entries, your exit strategy, and your overall trading approach.

Momentum Strategy

This approach involves trading in the direction of the trend after a pullback or correction in price movement. Momentum traders may also consider this a part of the breakout trade, as the price is hopefully showing momentum after the break.

Some traders may view trading the reversal out of a pullback as more of a momentum play, while others may have a different perspective. Ultimately, the key is to find a strategy that works for you. Regardless of the specific approach, it’s important to prioritize momentum in every trade to increase the chances of success.

This is a standard trendline and when the price pulls back to an area around the line, a break of the downtrend line on price can be the entry price. Sometimes adding a momentum indicator such as MACD or RSI and looking for a hook in the direction you want to trade, can be your entry.

Be sure to read our tutorial on trading pullbacks to learn more about this common price pattern.

ETF VS Mutual Funds

Understanding the distinctions between these two can impact your trading strategy and outcomes.

Market Dynamics and Flexibility: ETFs offer a distinct advantage in terms of market responsiveness. Unlike mutual funds, which are priced at the end of the trading day, ETFs are traded throughout the day on stock exchanges, similar to individual stocks. This allows for greater flexibility and the ability to react to market changes—an important aspect for swing traders who capitalize on short-term market movements.

Expense Ratios: Generally, ETFs are known for their lower expense ratios compared to mutual funds. This is due to their passive management style, as most ETFs track a specific index. Lower expenses mean more of your investment goes towards potential growth, rather than being eroded by fees.

Liquidity and Trading Volume: ETFs typically offer higher liquidity than mutual funds. This is particularly important for swing traders, as the ability to enter and exit positions quickly and with minimal slippage is key. The daily trading volume of ETFs can be substantial. For instance, in 2022, equity ETFs saw an average daily trading volume of $176.9 billion. This high liquidity also reduces the bid-ask spread, making it more cost-effective for traders.

Diversification and Risk Management: Both ETFs and mutual funds provide diversification, which is vital for risk management in swing trading. ETFs often offer more targeted investment options, allowing traders to focus on specific sectors, commodities, or personal interests. This targeted approach can be a powerful tool in a swing trader’s toolbox, enabling them to capitalize on specific market opportunities.

Tax Efficiency: ETFs are generally more tax-efficient than mutual funds. This is due to their unique structure and the way transactions are executed within the fund, often resulting in fewer capital gains tax liabilities for the investor (country-specific).

Accessibility and Minimum Investment: ETFs are accessible to all levels of investors, often with no minimum investment requirement. This contrasts with many mutual funds, which may have minimum investment thresholds, making them less accessible to the average swing trader.

While both ETFs and mutual funds have their place, the flexibility, lower costs, higher liquidity, and specific investment opportunities offered by ETFs make them a more suitable choice for swing trading. As always, traders should consider their individual strategies, risk tolerance, and investment goals when making their choices.

Why Choose To Swing Trade ETFs

ETF Trading Tip:  ETF Liquidity

ETFs for swing trading should have ample amounts of liquidity.  Simply looking at the volume of the ETF is not enough. Two key factors that determine ETF liquidity are the number of shares available for trading and the activity of traders, as well as the liquidity of each security within the fund.

An ETF that invests in securities with limited supply may be difficult to trade, so it’s best to stick with popular ETFs such as SPY, SQQQ, XLF, QQQ, and EMM. By carefully considering ETF liquidity, traders can make better decisions and potentially avoid trading difficulties.

Like Stocks, But Not Exactly

While there are similarities with stocks, individual stock prices rise and fall on the basis of supply, demand, and the outlook for the company. There are only so many shares of stocks that are available (supply). With an ETF, the market maker can create units (open-ended) so there is no supply issue. The ETF price is based on the value of all the securities held in the portfolio.

Frequently Asked Questions

Can ETFs be used for Swing Trading?

Yes, ETFs (Exchange Traded Funds) can be used for swing trading. ETFs are a popular choice for traders because they offer diversification across a range of assets, such as stocks, bonds, and commodities, and can be traded like a stock on an exchange. Not all ETFs are suitable for swing trading, and traders should carefully consider factors such as liquidity, volatility, and trading volume before making any trades.

What exactly is Swing Trading and how does it work?

Swing trading is a form of trading that involves holding positions for a short period of time, usually a few days to a few weeks, with the goal of profiting from price fluctuations in the market. This strategy is often used in the stock market, but can also be applied to ETFs (exchange-traded funds) and other financial instruments.

What is an ETF?

ETF stands for exchange-traded fund. It is a type of investment fund that is traded on stock exchanges, much like individual stocks. An ETF holds a basket of assets, such as stocks, bonds, or commodities, and investors can buy or sell shares in the ETF throughout the trading day. ETFs are popular among investors who want to diversify their portfolios without having to buy individual stocks or bonds. They are also commonly used for swing trading, a trading strategy that involves holding securities for a short period of time, usually a few days to a few weeks, in order to profit from price fluctuations.

Why are ETFs a good choice for Swing Trading?

ETFs (Exchange Traded Funds) are a good choice for swing trading because they offer a diversified portfolio of stocks or bonds that can be traded like individual stocks. This means that traders can take advantage of short-term price movements in the market without having to pick individual stocks or bonds. ETFs are also highly liquid, meaning that they can be bought and sold quickly and easily, which is important for traders who need to move in and out of positions quickly. ETFs often have lower fees than mutual funds, making them an attractive option for cost-conscious traders.

How to Exit an ETF Swing Trade

Exiting an ETF swing trade involves several steps. First, you need to identify your exit strategy before entering the trade. This includes setting a stop-loss order to limit potential losses and a profit target to take profits. Once you have entered the trade, monitor it closely and adjust your stop loss and profit target as needed based on market conditions. If the trade reaches your profit target, sell the ETF and take your profits. If the trade hits your stop loss, sell the ETF to limit your losses. It’s important to have a clear exit strategy in place before entering any swing trade, as emotions can cloud your judgment and lead to poor decisions.

Conclusion

With their blend of liquidity, lower costs, and diverse investment options, ETFs stand out as a decent choice for both novice and experienced swing traders. By understanding the makeup of ETFs and applying the strategies in this article, you can capitalize on the ETF opportunity and enhance your trading portfolio.