Skip to main content

How to Trade Momentum?

* Source: aWanderingMind.Life.

What is Momentum Trading?

Momentum trading is a trading strategy that aims to capitalize on the continuation of existing trends in the market. The momentum trader buys stocks that have been rising and sells those that have been falling, attempting to profit from the inertia of trends as they unfold.

The core principle is that price trends tend to persist and gain momentum over time. Stocks with upward momentum tend to continue rising, while stocks with downward momentum tend to keep falling. Momentum traders try to identify these trends early and ride the wave until it shows signs of reversal.

How Momentum Trading Works

Momentum traders use technical indicators like moving averages, the relative strength index (RSI) and stochastics to identify stocks with momentum. Generally, stocks trading above their 20-day and 50-day moving averages are considered uptrends, while those trading below them are downtrends.

An RSI above 70 suggests a stock is overbought and could reverse down soon. A stock with an RSI below 30 is oversold and could bounce back up. Momentum traders exit trades when the momentum appears exhausted and the stock could change direction.

Key aspects of momentum trading:

  • Identify stocks with strong momentum in a clear uptrend or downtrend.

  • Enter trades in the direction of the trend.

  • Use stop losses to limit the downside if the momentum fades.

  • Take quick profits as momentum starts slowing. Don't wait for a reversal.

  • Cut losses quickly if momentum stalls out or reverses. Don't hope it will resume.

  • Avoid fundamentally weak companies, even if they show price momentum.

Benefits of Momentum Trading

Some key benefits of momentum trading are:

  • Capitalizes on the persistence of existing trends.

  • Clear entry/exit rules based on momentum.

  • Doesn't rely on fundamental analysis of companies.

  • Quick profits as you ride momentum waves.

  • Defined stop losses limit downside.

  • Risk is lower if you cut losses quickly.

Risks of Momentum Trading

Some risks to keep in mind:

  • Momentum can reverse rapidly, leading to whipsaws.

  • Overreliance on momentum alone can be risky.

  • Momentum indicators can give false signals.

  • Trading costs from a high volume of trades can add up.

  • It's hard to succeed in choppy or range-bound markets.

Best Practices for Momentum Trading

Here are some tips for effectively trading momentum:

  • Use multiple indicators like moving averages, RSI, Bollinger bands to identify momentum.

  • Always use stop losses to limit potential losses.

  • Book profits quickly as momentum starts fading. Don't get greedy.

  • Cut losses short and don't average down on losing momentum stocks.

  • Trade with the overall market trend for higher probability trades.

  • Use larger position sizes for strongly trending stocks.

  • Avoid stocks making new highs on low volume or divergence on indicators.

Common Momentum Trading Strategies

Some popular momentum strategies are:

  • Trend Following - Trading in direction of strong uptrends/downtrends.

  • Breakouts - Trading breakouts above resistance or below support.

  • Reversals - Fading moves that appear overextended and ready to reverse.

  • Relative Strength - Buying strong stocks, shorting weak stocks.

  • Gap and Go - Trading of stocks gaping up or down on earnings/news.

Momentum vs Other Styles

Compared to value and growth investing styles, momentum trading is more active and fast-paced. Value and growth investors buy based on fundamentals and hold long-term. Momentum traders buy based on technicals and hold short-term.

Momentum trading is riskier than buying and holding but offers the ability to profit from identifying emerging trends early on. It requires close monitoring of the markets, discipline, and risk management.

Getting Started with Momentum Trading

To start momentum trading:

  • Educate yourself thoroughly on momentum concepts and indicators.

  • Open a brokerage account that allows active trading and has low commissions.

  • Use a paper trading account initially to test your strategy.

  • Start with high volume, liquid stocks and ETFs. Avoid penny and thinly traded stocks.

  • Keep position sizes small initially as you gain experience.

  • Develop a trading plan with entry/exit rules and stick to it.

  • Review your trades periodically to improve your skills.

The Bottom Line

Momentum trading aims to capitalize on the persistence of trends in stock prices. It can generate quick profits, but requires proper risk management using stop losses. With education, discipline and experience, momentum trading can be a profitable investment approach.

By utilizing our affiliate links below, you contribute to our support:

Amazon: Help Support Us When You Shop on Amazon.com

Mint Mobile: Try Mint Mobile For As Low As $15/Month

Robinhood: Earn Free Stocks When You Sign Up

Webull: Earn Free Stocks When You Sign Up

Skylum: Save 30% on Luminar Neo - Premium Photo Editing Software

Visit our shop, where you can find photography and digital art prints by Finley Delouche: Lowcountry Home Decor

Comments

Post a Comment

Popular posts from this blog

How To Make Money Flipping NFTs

* Source: aWanderingMind.Life . The world of Non-Fungible Tokens (NFTs) is a rapidly evolving landscape, filled with a multitude of opportunities for profit. In this burgeoning digital asset space, one method that is steadily gaining popularity among enthusiasts is the act of "flipping" NFTs. This practice, akin to flipping real estate in the physical world, involves purchasing digital assets at a low price and then reselling them at a higher price. The goal is simple: to leverage market dynamics and earn a profit from the price differential. Platforms like OpenSea.io have emerged as popular marketplaces where this strategy can be employed, providing a user-friendly interface and a large user base that facilitates the buying and selling of NFTs. Understanding the strategy of NFT flipping, however, requires a closer examination. How do you identify which NFTs to flip? How can you discern between a valuable digital asset and one that is unlikely to yield a profit? One approach...
1 comment
Read more

Climate Change and Its Impact on Severe Weather Patterns: A Comprehensive Analysis

* Source: aWanderingMind.Life . Image by NOAA The climate crisis is no longer a future threat. We are living its devastating consequences right now, as rising global temperatures affect weather patterns across the planet. From scorching heatwaves to raging wildfires and powerful hurricanes, the evidence is clear: climate change is making weather more extreme and dangerous. But what exactly is the science behind this phenomenon? How does a warming planet lead to more frequent and intense storms, floods, droughts, and other events? In this comprehensive article, we’ll explore the undeniable connection between climate change and severe weather, examining the data, science, and real-world impacts. Understanding this link is crucial, as we grapple with the urgent need to mitigate climate effects and prevent even more catastrophic disruption. The Greenhouse Effect: Why a Few Extra Degrees Matter To grasp how climate change is affecting severe weather, we first need to understand the...
Post a Comment
Read more

What are Non-Fungible Tokens (NFT's)?

Non-Fungible Tokens A non-fungible token (NFT) is a unit of data stored on a digital ledger, called a blockchain, that certifies a digital asset to be unique and therefore not interchangeable. NFTs can be used to represent items such as photos, videos, audio, and other types of digital files. Access to any copy of the original file, however, is not restricted to the buyer of the NFT. While copies of these digital items are available for anyone to obtain, NFTs are tracked on blockchains to provide the owner with a proof of ownership that is separate from copyright. In simpler terms, when you mint an NFT, it is recorded on the blockchain, and any subsequent transfers to another party is also recorded on the blockchain allowing everyone accessing the blockchain to see who currently owns the NFT. Artists can also have the option of choosing to add a royalty payment as part of the fee for subsequent sales. For example: If <insert name of artist> mints a token and lists on the marketpl...
Post a Comment
Read more