Momentum Trading – Concept, Key Factors, How to Start, Indicators & more
In this article, we will dive into a significant aspect of Momentum Trading.
Momentum is everything when we try to achieve something in life. Somehow, someway, we always tend to make a decision based on the existing trend.
Such is also the case if you are someone who fancies financial assets trading.
Now, please note we are talking about long-term investments, not Day Trading or Scalping, where you need to rely on other factors. Here, we deal solely on investment rather than trading.
At first, we will explain to you a bit what Momentum trading is, assuming you have no or very little knowledge.
Then we will elaborate on how it works, the steps to get it done correctly, and what are the popular tools to do it.
Of course, there are some pros and cons that we must also discuss before our conclusion – whether you should invest based on Momentum or not.
About Momentum Trading
Understanding Momentum Trading is not much far away from where we usually use the term ‘Momentum.’ This also refers to a trend that the market is currently following.
In case you are wondering about this trend, we are referring to the price of a financial asset that keeps either increasing or decreasing over a period.
As we have already mentioned that Momentum Trading typically deals with Position Trading or long-term trading, Momentum Trading signifies the price fluctuations of a particular asset over a span.
However, there are several scopes too for short-term trades using Momentum.
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Factors that influence Momentum Trading
Understanding Momentum is essential for successful investment. Even though there are tons of factors that influence the Momentum, today we will talk about 3 significant ones.
They are as follows:
The first key factor is Volume. For those who are unsure of what we are referring to, Volume represents the total number of trades performed in a particular time frame.
Now by trades, we mean the total number of assets trading, not the total number of transactions over a period.
So, when you are trying to figure out the entry and exit points, we can guess whether the market streams are stable or not.
Therefore, if the traded Volume is high, i.e., a greater number of buyers and sellers, you can expect quicker exchanges. Whereas, if the Volume is low, you may feel challenging to trade.
If the price of an asset remains flat for a long time, no one can earn profits to the level a trader expects. That is why Volatility in the market is essential.
It is one of the crucial factors that determine the potential earning. So, in simple terms, the unsure price fluctuation of a financial asset is called Volatility.
Now, there can be two types of Volatilities – high and low. When the price movement in the market is either hitting highs or hitting lows, you can say that the market is highly volatile.
Similarly, if the price fluctuations are not that much significant, it is low volatile. Typically, traders look for highly volatile markets which open doors to higher earning scopes.
Perhaps the most critical aspect is the amount of time the Momentum holds its strength. Time Frame is an essential factor as this determines what sort of trading you are interested in doing.
You can look for long term trading, or you can be a Day Trader. Based on the duration of the Momentum, you can make a decision whether or not you should invest in a particular asset or not.
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How to Start Momentum Trading?
To be clear, there is no guidebook to perform Momentum Trading. However, if you follow some set principles, the chances of successful trading improve significantly.
So, check out the following steps:
Choose an Asset
Whether you do Day Trading, Scaling, or Position Trading, the first obvious step is to select an asset that you trust.
There are several forms of investment that you might get interested such as Stock trading, Commodities, Currency trading, and many more.
Once you identify your ideal form of trading you can start the research.
Do Fundamental Analysis
Right after the asset selection, the next step is to perform the Fundamental Analysis.
In case you are wondering what that is, it is to make a thorough report on how the company is performing since its inception. You must check out every aspect of the company.
That not just mean whether or not it is making a profit, but also includes the future potentialities, the industry domain, the company’s current personnel, and many more.
Do Technical Analysis
After you complete the Fundamental analysis, the next step is to perform the Technical analysis. It simply means to understand how the asset is performing over the years.
Once you have an idea with a detailed stat, you can start planning an entry and an exit point using various Momentum indicators like the Moving Average Convergence Divergence (MACD), the Relative Strength Index (RSI), the Average Directional Index (ADX), and many more.
Demo or Virtual Trading before going Live
Once you are satisfied with all the researches, and you are feeling the stars are aligned to make the investment, you should begin trading.
However, most broking agencies offer Demo accounts, where you can practice trading risk-free.
They usually provide virtual funds to invest; so, you should make the most use of this before going live.
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Understanding Convergence and Divergence
In general terms, Convergence means a state where two or more things come closer, while Divergence suggests things are moving apart.
In case you are wondering how this is relevant here, it plays a crucial role while we try the deeper meaning of Momentum Trading.
While you are doing Technical analysis of any particular asset, you can typically see the price line and an indicator line.
In the trading fraternity, indicators are the graphical representation of the performance of an asset over a particular time-frame.
In context to Momentum Trading, when the price line and the indicator line follow the same trend, we call it Convergence.
It means the Momentum strength is strong, and usually, it is hard to make an entry in such market condition. Divergence, on the other hand, is the opposite phenomenon.
When the price line crosses the indicator line, both the lines go on the opposite direction from there onwards. That, we believe, is the ideal scenario to make an entry in the market.
Popular Momentum Trading Indicators
Momentum trading indicators play a crucial role in figuring out the Momentum itself. So, we will figure out 4 most popular indicators down below:
The Momentum Indicator is one of the most popular tools to figure out the Momentum of any particular asset. Basically, what it does is to find out the strength of the Momentum.
It does that by comparing the closing price with the opening price. It is an oscillator that resembles a chart starting from 0 to 100.
Relative strength index (RSI)
The Relative strength index (RSI) is also an oscillator which you can express in a chart from 0 to 100. You can find out whether the asset is Overbought or Oversold using this tool.
If the chart says 70, it is Overbought, whereas, if it stays below 30, it is Oversold. Now, anything in between 30 – 70 is where you should make an entry.
Moving averages is the next tool which is a bit conventional. It is not a Momentum-based indicator as most of the others are. Traders use this to figure out the emerging trends in the market using a formula.
A stochastic Oscillator is an incredible tool for identifying the Momentum of a particular asset.
It works similar to the Moving average indicator and follows the same principle of Overbought and Oversold. However, most experts rate Stochastic Oscillator higher than the MA indicator.
The difference between Stochastic Oscillator and other indicators is it doesn’t necessarily follow the price or volume of an asset. Instead, it focuses on the speed and momentum of the underlying market.
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How to approach Momentum Trading in Futures Market?
The Futures trading can be a complicated procedure. However, in order to implement Momentum in Futures trading, you can apply the following steps:
- You can buy assets at a high price and sell at an, even more, higher price.
- We can trail your stop loss so that you can ride on the current market trend.
- You can simply follow the price without complicating things.
- Should you incur a loss in trade, it will not cost much of your capital investment.
- We recommend you to invest in a variety of trading markets.
Momentum Trading – Conclusion
So, this is all we have to offer about Momentum Trading. It is very effective whether you are a Day Trader, a Scalper, and most efficient if you trade long-terms.
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