Greetings traders and welcome back to another Survival Guide.
Chris here, bringing you some more information,
and today, that information is going to revolve around momentum trading.
This is going to cover exactly what momentum trading is,
how it came about, what the components of momentum trading are,
as well as the some of the most popular momentum trading
indicators out there, and some momentum trading strategies as well.
Before we go any further, please click that like and subscribe
button down below, it helps me out a great deal because it allows
me to keep coming out with these videos for you guys.
Without further ado, let's dive on into that material and learn about that momentum.
Momentum trading has been, and will continue to be, a hot topic
amongst traders for quite some time, as many traders, the elites
on Wall Street to name a few, have used this, and continue
to use this on a daily basis, or at least incorporate some
of the momentum trading indicators into their repertoire.
But first, what is momentum trading?
Momentum trading is a strategy that looks at the strength of recent price movements
of a particular asset to determine the best time to buy or sell.
The idea here is that if there is enough strength
behind the price action, then it's likely to continue in that direction.
If the direction was bullish, then we expect bullish action
to therefore continue. In physics, the term momentum simply
refers to the quantity of motion of an object. The greater
the force, the longer the object will be in motion, until it
encounters an equally strong force to counter it.
It's a similar principle with momentum investing as well.
If we were to say that the price of an asset starts to go
up, and then we notice that more buyers are interested in
entering the market, this them can cause the market price
to go even higher. This momentum will likely go on until sellers
start to enter the market, causing it to stall. Eventually
once the sellers outnumber the buyers, the price will generally
drop, and the momentum will change direction. As a momentum
trader, our focus is on identifying assets with strong momentum
and then taking the corresponding position to
take advantage of the expected price movement. When the momentum
starts to sputter out, we then close the position out and gather our profits.
Momentum trading has been in existence for hundreds of years,
as far back as the late 1700's. British
classical economist, David Ricardo was known
to have used a series of trading strategies
based on momentum investing to achieve great success in the markets.
By 1937, the idea was formalized in academic studies and has since
been used by notable traders including Jesse Livermore, as well as Richard Dennis.
However, it is the famous fund manager and investor,
Richard Driehaus who is credited with being the father of momentum trading.
He believed that he could make more profit by buying
a security at a rising price, and selling it at an even higher
price, in contrast to buying an underpriced asset and waiting
for the market to turn. Today, momentum investing can be used
in several markets including the stock market, the commodities
market, the futures market, and even the Forex markets.
There are three main components to consider when it comes to momentum trading.
The first is volume. Volume simply refers to the
quantity of a particular security that is traded over a given
period. Keep in mind that this is not the same as the number
of transactions, but how much of the asset was actually bought or sold.
Volume is important to momentum trading because it
tells the trader whether that asset has enough supply and
demand, as well as whether it is easy or difficult to trade.
Momentum traders go for high-volume securities because
it means the market is liquid, which allows them to quickly
enter or exit the market as needed.
Generally speaking, we want more volume while momentum trading.
Number two is going to be volatility. Volatility is
a measure of how much change occurs within a price movement
over a given period. High volatility means the asset has experienced
huge erratic price swings, which a momentum trader will typically
favor. That's because momentum traders can take advantage
of short-term price changes. That being said, a highly volatile
market also means the price can swing the other direction
and result in large losses as well. As such, it's always important
to have a solid risk management system in place, or use something like a stop loss.
The third component is the time frame. The momentum trading
strategies that are out there generally focus on the short
term, especially since price movements usually don't maintain
their direction for long in volatile markets.
However, there are cases where the price action can sustain
its trend in a particular direction for a longer period of
time. The actual time frame does depend on the strength and
duration of the momentum being measured. This makes momentum
trading suitable for both short and long term traders, but
we do need to be aware of the time frame, and the momentum
as it applies to it, when we are momentum trading.
There are two main types of momentum that we should be aware of.
The first is absolute. The second is relative.
The prevailing difference between them is how they analyze
the price action of an asset and it's resulting momentum.
Absolute momentum looks at the price performance of the asset
compared to the past movements over a given period. It's basically
comparing price momentum against its historical
self. On the other hand, relative momentum compares the price performance
of individual assets against the price movements of other assets within the same class.
For example, let's say that the price of silver is going
up, and we want to buy some. We'd first
look at the price action of other precious metals, like gold
and platinum, to get a general idea of the overall asset class momentum, as a category.
How can momentum trading help us as traders?
Well, when it's executed properly, momentum trading can help
us identify profitable entry and exit locations.
Momentum is a good way to evaluate price action since rising prices
typically attract even more buyers, thereby pushing up the price farther.
It's that self-fulfilling prophecy idea.
Once you've confirmed the momentum, you can take an entry
position and make a profit as long as the momentum continues.
On the flip side, when the price does fall, sellers flock to the market pushing
the price even lower. Once we've confirmed with the trend
that the momentum is indeed going downward,
we can then exit the position and avoid incurring any extra
losses that are anticipated as the market continues to drop.
Momentum investing has become increasingly popular, especially
with advancements in the financial technology that traders have access to nowadays.
There are now smart trading algorithms that can quickly identify
the strengths of an asset's price movement
and take an upward or downward position accordingly in just
a matter of seconds. As more buyers or sellers jump in, the
momentum intensifies, and that idea of that ever rolling snowball
is what we as momentum traders are looking to take advantage of.
Because momentum trading is mostly concerned with monitoring
price action, it's natural for traders to rely on technical analysis indicators
to help confirm the momentum before taking a position.
Here, we have a list of some of the most popular momentum indicators
out there that can allow us as traders to gain some type of
insight, or some type of confirmation, into the read of the
current market or current asset's momentum that we are trying
to gauge. The first is the moving average.
This is probably the most popular indicator of all time, just
due to the fact that it's widely used by just about any style
of trader. A moving average is used to identify the prevailing
price trend of the traded asset over a particular period,
whatever you have that period set to. It plots the price movements
of a security in relation to its average price over a particular
time frame. This helps us as momentum traders spot potential
emerging trends. Moving averages are a lagging indicator,
so that should be mentioned, meaning they are always going
to be lagging slightly behind because they're averaging historical price together,
but nonetheless, they are a wonderful source to help confirm a read on momentum.
Then we have stochastics. Stochastics is another momentum
indicator that evaluates the closing price of a security
in relation to its price over a given period. The stochastics
are used to identify whether the asset is overbought or oversold
through a bounded range of values that range from 0 to 100.
If the asset is deemed overbought, then it's usually due for
a correction in the near future, and the trader might sell.
If the reverse were to hold true,
then the trader might buy. Next, we have on balance volume, otherwise
known as OBV. On balance volume measures buying and selling
pressure, in an attempt to predict price changes.
It is represented on the chart as a line that tracks the
daily volume over a given period. If the current volume closes
above the volume of the previous day,
it is considered positive. If it closes below that particular
number, then it is considered negative. OBV is essential in
momentum trading because it provides reliable feedback when
trying to confirm the underlying trend. It allows these traders
to potentially identify price changes as they happen.
Then, we have the stochastic momentum index, otherwise known
as the SMI, and we'll just underline all of it, just to make
it uniform I suppose. So like other oscillators, the stochastic
momentum index measures the strength of a price movement to confirm
a potential momentum behind the market move.
The main difference is that the SMI uses a wider range of
values and is more sensitive to the closing prices themselves.
Rising closing prices that are above the median of the low
or high price ranges, signify that the market is bullish. Conversely,
dropping closing prices below the medium of the low high
price ranges, indicate a market downtrend.
This is what makes the SMI particularly useful in identifying
momentum while investing. Then we have the MACD.
This is also referred to, or it's more fully referred to, as
the moving average convergence divergence, but you'll almost
never see that fully spelled out. The MACD comprises of two moving average.
There's a fast and slow exponential moving averages inside
the MACD, and they're compared against what is called a signal
line. The EMA lines converge, diverge, and overlap with each
other on the chart, indicating the changes in momentum.
In this way, the momentum trader can help
identify market trends by paying attention to the interaction of these lines.
Next we have the ADI, which is the average directional index.
This tool is used to determine the direction and strength
of a particular price trend. On a chart, the ADX can help show
whether we should be entering or exiting the market, or whether
we should even consider taking a trade just to begin with.
This helps us make informed trading decisions, especially
when used in conjunction with other momentum indicators.
Next up, we have the commodity channel index. The commodity channel
index is an oscillator, yet another oscillator on this list,
and it compares the current price of the security to its
average price over a given period of time. Momentum traders
can use the CCI to compare price action over multiple periods,
in order to identify dominant market trends and make a more informed decision.
Then finally, we have my personal favorite, the RSI, which
is called the relative strength index. The RSI measures the
strength of recent price action, and the speed at which they
change, to determine ideal entry and exit locations.
As an oscillator tool, it also shows whether the security is currently
overbought or oversold and is measured on a 0 through 100 scale. If the
indicator is below 30, then it indicates the stock is oversold
and will likely bounce back. This attracts buyers to the market,
which in turn can fuel momentum. If it is above 70, then it
might be deemed overbought and there will likely be a sell-off
in the next couple of trading sessions, depending on whatever
periods we have measured.
At the core of momentum trading, the idea is relatively
simple. We're looking to cut our losses when the momentum
stalls, or looking to jump into a position once we've identified
that a particular security how strong momentum and continue
riding in that direction. Some of the strategies that entail
being good as a momentum trader include paying attention
to things like looking for highs. When considering price momentum,
if we look for securities with steady consecutive closing
highs over time, this can give us a good idea
of which securities have sufficient momentum and are
worth our time to invest in. As a momentum trader,
it's usually pretty important to confirm that the market
is not just closing at a new high, but instead consecutively
closing at new highs. Then we can also focus on checking resistance
levels. Securities that are testing their resistance levels
are usually ideal for momentum trading, since they can intensify
buying and selling pressure if they do break through that particular resistance.
However, it is not enough that the asset breaks its resistance
to just jump in alone by the rules of momentum trading.
This is where our knowledge of technical momentum indicators will
be useful to help confirm that the break is worth our time.
Also, we have a watch list. Momentum traders typically
have a watch list of securities that they monitor outside
of the chart information that they're currently looking at.
Political upheavals, health pandemics, and global unrest can
significantly sway market direction,
so it's important to stay in the loop with current affairs,
meaning whatever it is that we plan to momentum trading,
we kind of want to pay attention to it on a daily basis as well.
Then we finally have tame the herd.
Generally speaking, being a successful trader means identifying
the top and bottom of a market trend to enter or exit at
the most profitable point.
Well, this doesn't necessarily hold true for momentum trading.
Instead, our focus is on being in the main body of the price
action and letting that herd mentality and the fear of missing
out of other market participants continue to push our position
towards that profitable nature. The top three advantages of
momentum trading, in my opinion, begin with the potential for
high profit over a short period. If the security we are
trading is backed by strong momentum,
then we're generally expecting some strong steady profits
for the duration of that trend.
Then number two is the benefit of market volatility on momentum.
Many traders stay away from volatile securities because of
the risks involved, but that just leaves room for momentum
traders to step in and make some profit due to those larger
moves. Number three is that momentum trading allows us
to benefit from the emotional decisions of other traders.
The herd mentality can push that buying or selling pressure
of the security that we're trading, farther in the direction
that we want, and we are looking to take advantage of this.
That means all we have to do is pick our asset and wait
for those emotionally involved traders to push the pace and just ride the wave.
The potential disadvantages can be summed up in these two categories, in my opinion.
We have that it can be quite time intensive. Being a successful
momentum trader does require us to spend a lot of time monitoring
the market, and sometimes this means studying charts every
hour of the day in order to look for that ideal trade.
There is a time investment to momentum trading and being
aware of the things like news. Which brings us to number two,
the sensitivity to news can be considered a downside for
momentum trading. No trading method is without it's risk, and momentum
trading, the market is extra sensitive to external news, and
a rising momentum can just as quickly start to go down due
to a particular unexpected news release, so that can unfortunately
hurt our momentum swings that we are already engaged in.
In conclusion, momentum trading is another style of trading
that can be extremely profitable and lucrative to a trader
once they understand and practice it correctly.
I personally do enjoy momentum trading because I like going with the flow of
the market instead of feeling like I'm trying to
stop a freight train, or trying to catch a falling
knife by buying the bottom perfectly, or selling the top perfectly.
It feels a lot easier in some sense to actually just go with
the momentum of the market in general, but it is up to you
to decide what type of trading style best suits you and to
employ the correct practices if you do so engage on a momentum
trading journey. Until next time folks, please click
that like and subscribe button down below so you can
be notified the next time we come out with a video for you.
I will see you all soon. Happy trading everybody.
Good luck and happy hunting.