Trading with Momentum: An Overview

On paper, momentum investing looks more like a reflexive response to market news than a deliberate approach. Although it may seem appealing, selling losing stocks and buying winning ones contradicts the old Wall Street maxim of "buy cheap, sell high." The advantages and disadvantages of momentum investing are discussed here.

An Early Pioneer In Momentum Investing

Richard Driehaus was one of many to adopt momentum investing in managing his money. He believed that "buying high and selling higher" was the best investment strategy since it yielded greater profits than waiting for stock prices to drop before purchasing.

Driehaus advocated getting out of losing positions and holding on to winning ones while reinvesting the proceeds from the latter into companies that showed signs of heating up.

Investing In The Momentum: Some Basics

The goal of momentum investing is to profit from short-term price fluctuations by purchasing rising equities and quickly selling them when they show reversal symptoms. The investor then redistributes the money to other projects. Momentum investors, in this scenario, are like sailors riding the crest of a wave before jumping to the next one before the previous one falls back down.

The Building Blocks of Momentum Investing

To mitigate the negative effects of price volatility, crowding, and unanticipated losses, traders in momentum markets need access to sophisticated risk management rules. In the face of irrational fears that they may miss the rally or selloff and consequent windfall profits, market participants consistently disregard these guidelines. The guidelines consist of the following five parts:

1. Electing which stocks to invest in
2. Timing trades open and close risks.
3. Early entry means entering the trade.
4. Position management integrates large spreads and holding terms.
5. Exit points need to be charted regularly.

Inspiring Choice in a Volatile Market

To engage in a momentum strategy, you should invest in liquid securities. Steer clear from leveraged or inverse ETFs since the price movements of these investments don't correspond with those of the indexes or futures markets they are supposed to monitor. Ordinary funds are effective trading vehicles, but their profits and losses are often lower than those of individual stocks. Look for stocks with a daily trading volume of more than 5 million shares.

The Timing of Your Entrance Is Right

The finest opportunities for momentum trading arise when unexpected events cause significant market fluctuations. This triggers to buy or sell signals, which astute players can act upon for immediate gains. As the trade progresses, more money momentum flows in, causing counter swings that shake away weak hands. When the number of "hot money" investors reaches a critical mass, it can cause wild price swings and abrupt reversals.

Controlling Your Placement

As the bid/ask spreads on these securities are typically rather large, mastering position management is time-consuming. In addition to grinding through broad intraday ranges that expose stops, wide spreads necessitate a larger move in your favour to turn a profit, even if the underlying technicals stay unchanged.

Choose your holding term prudently since the potential for loss grows with time. Day trading is useful for momentum techniques but requires larger bets to offset the higher potential rewards of holding for several days.

Gainful Retirement

Go out before the price reaches an overbought or oversold technical level. A succession of vertical bars on a 60-minute chart is a common indicator of an overextended condition. The price may also break over the upper or lower boundary of the 20-day Bollinger Band by three or four standard deviations. When technical hurdles are breached, such as a key trendline or a prior high/low, tighten stops or think about making a blind exit. It may be time to cash out or take a partial profit when crossovers occur.

Is It Right for You?

Although momentum investing has shown some success, it may only be suitable for some traders. If you're an individual investor, you should know that momentum investing almost often fails. You will react to older news than the specialists at the helm of momentum investing funds, whether you buy a rising stock or sell a falling one.

Unfortunately, they will abandon you and the rest of us to pick up the pieces. Even if you plan it perfectly, you still need to be wary of the expenses associated with turnover and how much of a bite they will take out of your profits.

The Conclusion

While not everyone can succeed with momentum trading, those who can frequently reap substantial rewards. Trading this way requires extreme self-control since losing positions are liquidated immediately, and the money is invested in stronger positions. Many traders have been put off by factors like commissions that make this trading style unrealistic, but things are beginning to change as low-cost brokers play a larger part in the trading careers of short-term active traders.