What is Momentum Trading? Top Momentum Trading Strategies

Volume is not the number of transactions, but the number of assets traded – so, if five buyers purchase one asset each, it looks the same as if one buyer purchases five of the asset. Some significant aspects of momentum trading can help you to make quick profits. Market behaviour in an asset’s price is based on its relationship to past performances using historical time sequences. In his classic https://forex-review.net/ text on the advantages and disadvantages of various investing strategies, Investment Fables, Aswath Damodaran of the Stern School of Business at NYU states his doubts. Stocks tend to pop after issuing a solid earnings report, but this is often accompanied by a wave of analyst upgrades in the stock. Take a look at a Upstart’s (UPST 9.48%) chart since reporting better-than-expected earnings.

  1. However, it’s important to understand what goes into those calculations to better understand what variables are used in determining a stock’s momentum or trend.
  2. Though “momentum” can refer to fundamental measures of performance, such as revenue and earnings, it is most commonly used in reference to historical asset prices as a technical indicator.
  3. For that traders need to set up some kind of stocks scanning system (for example reversal trading strategies scanners).
  4. So, the market volatility is like waves in the ocean, with the momentum trader sailing up the crest of one, only to jump to the next wave before the first wave crashes down again.

Testimonials appearing on this website may not be representative of other clients or customers and is not a guarantee of future performance or success. Summed up, it is a strategy in which you use the strength of price movements to determine your trade entry and exit points. As a momentum trader, you buy only when the price is moving in your favour with the hopes of selling at a higher price. If you’re looking at a price momentum, you’re going to be looking at stocks and ETFs that have been continuously going up, day after day, week after week, and maybe even several months in a row. But it’s important to know that there’s a lot of evidence that shows markets making new highs have a tendency of making even higher highs.


To add to that, moving average convergence divergence (MACD) is calculated using an exponential moving average. Momentum trading is a strategy that seeks to capitalize on the momentum to enter a trend as it is picking up steam. In equities, broad market increases in corporate profits can help to create positive price momentum. In fixed-income securities, falling interest rates can be a catalyst for price momentum. They attempt to achieve alpha returns by investing in stocks that trend one way or another.

Level 1 vs. Level 2 Market Data

Buying high and selling higher is momentum traders’ enviable goal, but this goal does not come without its fair share of challenges. Choose your holding period wisely because risk increases the longer you stay positioned. Day trading works well with momentum strategies, but it forces players to take larger positions to compensate for the greater profit potential of multi-day holds. Conversely, it is best to reduce position size when holding through multiple sessions to allow for greater movement and stop placement further away from the current action. Stay away from leveraged or inverse ETFs because their price swings don’t accurately track underlying indices or futures markets due to complex fund construction.

Develop your trading skills

However, if the trader was risking $1/share to potentially make $3/share, the trade would be favorable. A high-probability setup is one that is likely to unfold a certain way. For example, a trader may recognize a certain chart pattern that results in a breakout 80% of the time.

I highly suggest you invest significant time learning how to use the various momentum indicators. By learning how to spot a momentum change, you can position yourself on the winning side of a trade. One golden rule all successful traders follow is they don’t chase stocks. Luckily, if you missed the first wave entry, swim around and wait to enter during the next consolidation period.

Momentum trading can be a good way to make money when things work out, but it can quickly result in big losses if things go the other way. Citing statistical data, Professor Damodaran further explains that, “Momentum stocks have an average beta almost twice that of the rest of the market … and are much more volatile.” When a stock rockets on a better-than-expected earnings release, for example, seconds can count. Good news can spark a nearly instantaneous rise in price, and the profits go only to the quickest clickers.

Momentum Trading

Or you may like looking at the percentage price change over just the last 12 weeks or 24 weeks. Generally, the former method is more sensitive to recent price movements. Alternatively, you can learn more about trading strategies and indicators with IG Academy’s range of online courses. While that is a good thing, it is still vital to backtest every strategy and understand the risks.

Momentum trading in the Futures market (a systematic approach)

For example, a news development may impact investor market perception and lead to widespread selling. Momentum trading strategies rely heavily on short-term market movements such as day trading and scalping. However, the duration of the trade can depend on how long the trend maintains its strength. Besides short-term trading, momentum traders focus on longer-term styles, such as position trading. There are several momentum indicators that technical analysts can use in momentum trading. Among the most popular include the relative strength indicator (RSI), price rate of change (ROC), stochastics, and moving average convergence divergence (MACD).

The stock soared higher by about 30% the day after, but it ended up adding another 30% on the positive momentum created by analysts and commentators over the next several weeks. Exit when the price is moving rapidly into an overextended technical state. This overextended state is often identified by a series of vertical bars on the 60-minute chart. Alternately, the price could pierce the third or fourth standard deviation of a top or bottom 20-day Bollinger Band. Momentum trading deviates notably from the investment strategy of buying low and waiting for a stock to rise. For example, stocks are prone to mean reversion, while in the crypto world, momentum has (so far) worked well.

Momentum trading strategies

Alternately, the price could pierce the third or fourth standard deviation of a top or bottom 20-day Bollinger Band (technical analysis tool). Driehaus believed in selling the losers and letting the winners ride while reinvesting the capital from the past losers in stocks starting to boil. As a result, many of the techniques he used became the basics of what is now considered momentum investing.

After that, the price likely has been over-extended for a while now, which means buyers will soon lose control. The wave is building rapidly; you snap into action, paddling like a crazy person toward it. For the love of God, you will nail this wave and ride it before the momentum (wave) dies out. What you’re looking for is trend continuation chart patterns (like Bull Flag, Ascending Triangle, etc.) to trade in the direction of the trend. So when volatility is low, you have a smaller stop loss — which allows you to increase your position size and still keep your risk constant (the dollar amount).

Conversely,  when a security’s price constantly remains at or below a moving average, a downtrend is usually reflected. The objective is to work with volatility by finding short-term upwardly trending buying opportunities and then selling when the securities lose momentum and repeating that process. The primary rationale behind momentum investing is that a well-established trend is likely to continue. As momentum traders, we look to time our entry before the crest of the wave hits. Smart traders don’t buy at the top of the wave when the price is at its peak. Welles Wilder Jr. in the late 1970s; his “New Concepts in Trading Systems” (1978) is now an investment-lit classic.

This requires a solid foundation of technical analysis, which is the study of chart patterns and indicators. Technical analysis enables you to analyze the price action and history to derive support, resistance and key price inflection points in order forex etoro review to map out a trading game plan to execute. Momentum trading strategy is the practice of buying and selling assets according to the recent strength of price trends. That is, it uses the strength of price movements as a basis for opening positions.

By employing a momentum investing strategy, investors look to profit from buying or selling short securities when they are strongly trending, i.e., have high price action momentum. A  marker of high momentum is a wide range of price advances or declines in a short period of time. Typically markets that show high momentum also witness increased volatility.

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