Momentum Trading Strategy is one of the most popular and best trading strategies to make money in the stock market. Unlike other trading strategies where the trader focuses on company’s financial performance and chart patterns, a momentum trader only focuses on stocks that are moving significantly in one direction or are trading in high volume.
How Does Momentum Trading Strategy Work ?
In momentum trading strategy, a trader primarily takes the advantage of short-term price movement in a stock. In other words, he takes the advantage of upward trends or downward trends in a stock price. He focuses on stocks that are in news and can be a high percentage or volume movers of the day.
A momentum trader buys and sells the stock within a few minutes or a couple of hours or by the end of the trading session. His decision entirely depends on how quickly the stock moves and gives price movement.
Not every stock can provide momentum; therefore finding the right stocks to trade in becomes very critical in momentum trading. A wrong stock can not only waste your time but can also incur losses. Here are 10 things that you should focus on while undertaking momentum trading strategy.
Factors to Focus on While Adopting Momentum Trading Strategy
Momentum day trader generally buys and sells a stock within the same day. In order to make a profit in a day trade, it is important that the stock you trade in has good volume i.e. there are enough buyers and sellers to trade in the stock. The high volume brings high liquidity and makes it easier for you to quickly buy and sell your stock.
Volatility and Range:
When you are looking for a stock which gives significant moves in a day trade, a range-bound and non-volatile stock is a strict no. They give you very less or no trading opportunity. So always look for volatile stock which can show good volatility and range.
Unlike other trading strategies where a trader focuses on long term performance of the stock, in momentum trading, a trader is only concerned about short term price moves. So pay attention to the day performance of the stock instead of looking at the company’s performance in the long run.
Momentum trading stresses more on technical analysis instead of fundamental analysis. Technical analysis involves the study of charts and graphs to understand the buy and sell signals.
For successful momentum trading, a trader must identify the catalysts that have the capacity to drastically drive the stock and cause a breakout or breakdown in the price. A catalyst can be anything such as a new product announcement, news of the merger,earnings report, etc.
Risk Reward Ratio:
Momentum day trading is characterized by high risk and high reward. However, you can mitigate the risk by doing good research and finding stocks with favorable risk reward ratio. Risk reward ratio of 1:3 or greater is considered to be favorable.
In momentum trading style, the basic assumption is that the stock trend will continue to move in the same direction because of the momentum behind it. Therefore, a momentum trader must follow the stock trend. Trading against the stock trend can increase your risk.
Stock market is highly volatile. There are various factors which bring volatility in different sectors like a change in the laws pertaining to a particular sector or a major event affecting a particular sector. These volatile factors affect the overall sector and all the industries within the sector. So an understanding of sector trends can help you to identify the stocks to trade in.
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For a successful trade, one must pay attention to the market trends. You must analyse the market strengths and weaknesses to predict the market momentum. This will help you make better trade decisions.
Entry and Exit Strategy:
A momentum trader must know in advance his entry and exit strategy. He can enter the stock when there are signs of short-term strength or he can wait for a pullback and buy on weakness. Similarly, depending on his expectation of profit and risk appetite, he must determine his exit strategy.
Momentum trading strategy has a huge potential and if done with sufficient knowledge of techniques and understanding of risks, a trader can earn high returns. At www.tradingfuel.com we provide informative and knowledge sharing blogs, articles and videos on the stock market. Read our other blogs to gain an insight into the stock market.