Momentum trading is about trading in favor of the market trend. The strategy is based on assuming that an asset moving strongly in one direction will continue to do so. This type of operation is one of the most popular among beginning traders , since its most basic strategy does not require great knowledge about the structure of the market.
There is no doubt that the market trend can change at any time . However, it is less likely to do so when the movement is powerful or accelerating.
Here are some indicators that can be useful to detect momentum .
Volume in momentum trading
The volume of an asset is the gasoline that pushes the price to continue its trend. A strong and growing volume can be an important indicator that traders’ interest is going in that direction and the trend can be prolonged.
On the contrary, when the volume is turned off, it could mean a weakening of the movement. In momentum trading , this can be a good point to exit the position in the event of a probable change in trend.
Moving averages are probably the most popular indicator among any type of trader. From day trading to long-term investments. The reason is simple: moving averages mark the trend that the price has had for a specified number of days. They will tell us, therefore, if the momentum is positive, negative or relatively stable.
When the price exceeds or falls below a moving average it can indicate that a new trend begins. The most important question is deciding which moving average to use. For day traders or swing traders, a moving average of 10 periods (1-5 minutes for the first and days for the second) can be useful. For those who want to hold a position for longer, the 50 or 200 day moving averages are the most common. A break in these averages will mean a change in trend.
The impact of the news on momentum trading
When trading in favor of the trend it is important to take into account the news or events related to the company that can affect the price. An example of this type of event is the presentation of quarterly results. The price of a company with an uptrend that shows surprisingly positive results can further drive that trend. And, in addition, with a significant volume. On the contrary, a balance of results much worse than expected could break the trend and cause a significant drop in the price.
Often times, price trends are also reflected on social networks such as Twitter . The number of positive or negative tweets and comments about a stock often fluctuates as the stock price fluctuates.
Think about your way out
Usually, after a strong trend, the price tends to go back at least part of the distance. It is always a good time to collect profits, especially when the volume starts to drop. Reducing a position there or closing it completely is an option to consider.
Another exit strategy is to reduce the position while reaching certain supports or resistances. Either in price or when they touch areas close to the moving averages. In any case, you always have to keep in mind the point or conditions in which we will exit the position.
Taking all of this into account and using a combination of volume, moving averages and attention to company-related events, we can do momentum trading . The trend is your friend.