Momentum trading tracks the up and down market swings and trades the predominate trend. Momentum trading requires mental focus.  You have to stay firm until you reach your targets, while employing significant levels of discipline to avoid temptation.  Trying to enact short-term momentum trading is a very difficult way to earn a profit, and thus, it is not for the faint of heart.  However, for the savvy investor, it can be quite profitable for your portfolio.

Monitoring momentum

There are different ways that you can enter into momentum trading.  Using the impulse system, you measure the inertia of the market, as well as the market’s momentum.  To find the inertia, you can look at the exponential moving average to see when it swings up and when it swings down.  If it goes up, it is a bull market; when it decreases, it is a bear market.  To find the momentum, you can look at the moving-average-convergence-divergence histogram, which shows the changes of power between the bull and bear markets.  If it is rising, the market is becoming more bullish, and if it is dropping, it is becoming more bearish.

The system than has an entry sign when the indicators are going in the same direction, and the sign to get out when they start to change.  If both are going up, then the bulls are in control, and if both are going down, the bears are in control.

Momentum timing

If your time frame goes along with the daily charts, then you should consider the weekly chart to see which direction the market is headed.  If you are thinking more long term, then a 26-week exponential moving average combined with the weekly moving-average-convergence-divergence will give you more information. Investor’s Business Daily’s web site www.investors.com and other premium investor sites have comprehensive charting and rating tools that will help you identify and trade market swings.

After you have determined the market’s current trend, you can use your daily information to find trades that will go along with the trend for the week.  By doing this, you can wait for trades that fit your comfort zone.
Thus, if the trend for the week is bullish, you should wait for both the exponential moving average and the moving-average-convergence-divergence to go up.  You can then buy, and stay in this position until the signals change.  On the other hand, if the market is bullish, wait for both signals to go down.  You should be ready to do this as soon as your buy signal vanishes.

The reason that momentum trading is valid in all types of markets is because you are watching the short-term momentum.  All markets will trend within a week, and strong stocks will show trends within a day.  This does mean that you have to be constantly ready.  You have to instantly exit when the indicators change, allowing you to sell when the time is right.  When the trend is down, you have to start watching the shorts as soon as either indicator stops showing sells.  You have to time this precisely to ensure that you are buying and selling just before a trend ends for maximum results.

Trading on momentum requires a delicate touch and fast reactions.  You have to manage the patience to wait for the perfect moment, and the speed to execute your trade when that moment hits.

Avoiding the pitfalls of momentum trading

The market changes tremendously because of greed and/or fear among investors, and these emotions can keep even smart investors from making savvy choices.  Beginner momentum traders often see dramatic initial gains as a combination of luck and fearlessness.  However, since many do not use a good strategy of risk management, they end up losing money in the long run.

If you gain big, it often makes you forget the times you lose big.  Confused newcomers start buying at the top and selling at the bottom, or forget the rules entirely by trying to hang onto winners and hope for a rebound.

Precision is the key to profits

Swing traders rely on a strict method to define their target execution point, which can be difficult to do in a quickly changing market.  Momentum markets often have no similarities, making it difficult to make a clean entry and exit.  Sometimes the only way to stop danger is to take random losses. In other words, don’t hang on to a stock waiting for it to turn around; it may not. Define your pain threshold and sell losers when they hit it, no matter what. Live to trade another day.

However, you can master momentum trading by learning some skills and developing discipline.  First, you have to abandon emotion.  Getting too excited about profits will keep you from making the disciplined decisions that you need to succeed.  Have a trading plan, entry point and exit point and stick to the plan. You need to know the plan and your own trading rules well enough that you can make instant decisions during your trading day.  In addition, you must learn to use objective measures to avoid any preconceived notions of what a stock will do.

Strategies to improve your risk to reward ratio

In order to be successful at momentum trading, you have to learn how to “read the tape”.  The demand shows the inner workings, and both small lot and large lot traders have to watch for the sharp trend.  Monitor where the crowd is going; if you cannot sense an urgency to jump in and buy a stock, there may not be support there.  Know what to do in uncharted territories, and watch the big players to see what they are doing so that you can get an edge.  In other words, constantly research and monitor the market; become one with the market. After a while, you may get to a point that you feel the market sentiment from all of your market tools; the best traders do.

The time of day influences the momentum as well.  At opening, overnight imbalance and new cash creates change.  The lunch hour doldrums can lead to a stop of gunning exercises.  Towards closing, you will see many sharp breakouts and breakdowns with the after 3 o’clock crowd.

Being able to analyze the market will allow you to find momentum secrets and watch for the emotions of the herd and the deception of insiders.  Learn to verify everything by watching for patterns and indicators.  Trade only by the numbers, and avoid emotions.

Momentum strategies are often unsuccessful, since stocks only trend 15-20% of the time.  You have to be flexible enough to move from one strategy to another as the market changes in order to see the most success.