In physics, momentum is defined as “mass in motion.” In the world of finance, momentum trading follows this concept using price trends. Momentum trading is where you buy and sell assets (stocks, commodities, currencies etc.) according to the movement of prices in the market.
Traders use the momentum strategy to buy or “go long” when the price rises and sell or “go short” as the value declines. Imagine that you jump on a moving train, knowing it is only going to go faster. Your strategy is then to look ahead for a red light and jump off the train in time.
Making A Profit
The idea behind momentum trading is to “buy high and sell higher.” Compare this to the popular “buy low and sell high.” Many traders are attracted to the momentum strategy because you buy an already strong asset. You do not have to wait for an undervalued stock to rise in value over time.
Momentum trading is based on the idea that neither price nor volume will move in one direction indefinitely. Traders seek to make a profit by predicting short-term price changes instead of long-term growth.
Strategies for Momentum Trading
There is no one ‘best momentum trading strategy.’ Momentum trading is based on volume, time frames, and volatility. Traders use various indicators to determine when to enter and exit trades, including moving averages, the stochastic oscillator, and the momentum indicator.
Essentially, there are two momentum trading strategies:
The time-series momentum strategy (TSMOM)
Time series momentum, otherwise known as a “trend-following strategy”, is a system of measuring the viability of assets based on their previous performance. It focuses purely on the asset in question, without comparing and contextualizing the data within the rest of the market.
This strategy ranks stocks on the basis of their performance. The best or top-performing stocks are assigned to a winner portfolio, while the loser portfolio collates the worst-performing stocks.
Tips for Momentum Strategy
There are plenty of online courses to help introduce you to momentum trading, from beginner to advanced. Trading forums are also a great source of information – although beware of fellow traders wishing to boost their own portfolio by recommending certain shares and strategies.
Time is of the essence in momentum trading – buy in too late and you may end at a loss. Also, bear in mind the transaction costs involved in making lots of short-term trades. Your best bet is to find an online broker who offers a reliable platform where you can try momentum trading with the right market tools on hand.
Find a broker you trust
Take TradeOr, for example. More than just a broker, this platform has fantastic tools for market insight and analysis and offers 24/7 customer support. TradeOr also lets you practice on a demo account with simulation money, making it an ideal gateway into playing the market for beginner traders.
It is easy to get bogged down in the details of the momentum trading strategy. There are many factors affecting momentum in the markets. Expert traders will consult detailed graphs and use financial analysis to make their trades. In essence, however, the momentum trading strategy is simple. You follow the direction of the market. When the price is high you buy. When the price is higher, you sell. Simple!