Momentum Trading and 3 Technical Indicators Explained

What is Momentum Trading

Momentum trading is a strategy that uses the strength of price movements as a basis for opening positions. Discover what momentum trading is, how it works and four popular momentum-based indicators you can use to get started. Volatility is a statistical measure of a market’s tendency or security to rise or fall sharply within a short period. It is essential for momentum traders to Momentum to find volatile markets to take advantage of short-term rises and falls in an asset’s value. Momentum investing seeks to take advantage of market volatility by taking short-term positions in stocks going up and selling them as soon as they show signs of going down. In this case, the market volatility is like waves in the ocean, and a momentum investor is sailing up the crest of one, only to jump to the next wave before the first wave crashes down again.

Even though there are certainly benefits to momentum trading, there are also drawbacks that you need to be aware of. First of all, since momentum trading relies so heavily on getting the timing just right, there’s always the risk of buying at the wrong time or predicting incorrectly. This can lead to substantial losses instead of the quick gains that momentum trading is used for.

Disadvantages of Momentum Trading:

If buys and sells are not timed correctly, they may result in significant losses. Most momentum traders use stop loss or some other risk management technique to minimize losses in a losing trade. Momentum traders will seek out volatile markets, in order to take advantage of short-term rises and falls in an asset’s value. As momentum trading attempts to capitalise on volatility, it is important to have a suitable risk management strategy in place to protect your trades from adverse market movements. Momentum trading strategies are the practice of buying and selling assets according to the recent strength of price trends. If you are a technical trader (as most momentum traders are), you should be guided by technical, not fundamentals.

Please ensure you understand how this product works and whether you can afford to take the high risk of losing money. While that is a good thing, it is still vital to backtest every strategy and understand the risks. It takes a lot of discipline to master risk management, as fast profits also mean the potential for fast losses, so you must reduce risks. In this example, the ADX strengthens as the EURGBP price moves above the 200-period moving average. This essentially gives us two independent pieces of evidence that suggests strength is building in the underlying price trend.

How to start momentum trading

Gross domestic product increased at a 2.1% annualized rate last quarter, the government said in its second estimate of GDP for the April-June period. Economists polled by Reuters had expected GDP for the second quarter would be unrevised. “Data point to steady economic momentum into the second half of the year and confirm that a recession isn’t on the near-term horizon.” 11 analysts revised their earnings estimate upwards in the last 60 days for fiscal 2023. The Zacks Consensus Estimate has increased $1.98 to $19.82 per share. With more than 800 top-rated stocks to choose from, it can certainly feel overwhelming to pick the ones that are right for you and your investing journey.

  • The Average Directional Index (ADX) is a favored momentum indicator and is typically less apt to produce false signals than the stochastic oscillator.
  • The same risk-return tradeoff that exists with other investing strategies also plays a hand in momentum investing.
  • As a momentum trader, you buy only when the price is moving in your favour with the hopes of selling at a higher price.
  • The zero line is essentially an area where the index or stock is likely trading sideways or has no trend.
  • So when you position yourself in a low volatility environment, there’s a good chance volatility could move in your favour.
  • Instead, this is a strategy that allows you to follow the emotions of other investors and predict how their reactions will affect the stock market.

Not every momentum trader is a trend-following trader, but momentum traders earn the largest profits when a strong trend is established by the emergence of momentum. The advantage of a momentum strategy is that you can participate in a price movement early on and have the opportunity to achieve a good return. Momentum trading is also a unique strategy in that it’s more of a logical method than an emotional one. It’s no secret that the stock market can be heavily influenced by the news and how investors generally react to news. Say, for example, that a major company is facing backlash over a controversial issue. This may drive investors away from the company, thus hurting their stock market performance.

Disadvantages of Momentum Trading

Yes, we work hard every day to teach day trading, swing trading, options futures, scalping, and all that fun trading stuff. But we also like to teach you what’s beneath the Foundation of the stock market. There are many successful traders who have achieved or continue to achieve outstanding results with momentum strategies. He remains inactive in bear markets but trades all the more aggressively in bull markets, sometimes betting 30 percent of his risk capital on a single highly liquid stock. Mark Minervini calls his strategy “SEPA” (specific entry point analysis). This approach, which he developed himself, uses quantitative screening, fundamental research, and qualitative analysis to identify stocks with the potential for high gains.

What is Momentum Trading

And with these principles, you can develop a momentum trading strategy for the stock markets. 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 What is Momentum Trading that a well-established trend is likely to continue. Volatility isn’t something all traders seek, but momentum traders looking for short-term trends must embrace some level of it. Stocks with minimal volatility generally won’t offer the opportunity to capitalize on market volatility that momentum traders are looking for.


To sum up, it’s crucial to understand that momentum trading does not come without its fair share of challenges. Essentially, you’re deciding to invest in a stock or ETF based on recent buying by other market participants. There’s no guarantee that buying pressures will continue to boost the price. Momentum investing is generally a short-term investing strategy, as the primary purpose of traders is to capture part of the price movement in a trend.

  • It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication.
  • Successful trading relies on having good information about the market for a stock.
  • Unlike the systematic approach where you’re buying every 50-week breakout, you can choose to be selective with your entries.
  • In addition, the monitoring of market opportunities can be incredibly time-consuming and often includes high transaction costs.
  • The thrill of making those predictions can be quite exciting and fun for some investors.

Over time, the profit potential increase using momentum investing can be staggeringly large. RSI, MACD, and ADX are among the most popular momentum indicators. We believe these indicators work much better as reversal indicators, but other traders might find them more valuable than we do. We prefer to look at price action to measure momentum (where the price is compared to N-days ago).

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