The common path newbie investors take is the basic method of investing. Which is buying stocks and waiting for their prices to hike before selling.
But what if we told you that momentum trades are not only easier but also more profitable?
You read that right.
Learn about momentum trades today by reading below. We’ll tell you everything you need to know, including how to start, which indicators to use, and even its risks!
What is Momentum Trading?
The word momentum defines an object in motion and the quantity of its movement.
And just like a car can gain or lose momentum, so can your investments.
One of the widely used investing strategies is momentum trading. It capitalizes on the directional trends of a stock’s price.
So how does it do that?
Stock prices often follow directional trends. Which root from tangible events or catalysts such as analyst upgrades.
These trends can be spotted with the use of technical analysis. This is where trading indicators come into play. There are thousands of indicators to choose from based on your needs. Some put emphasis on current prices, some on volume, etc.
Now, when using the momentum trading strategy, you’ll either buy low, sell high, or buy high and sell even higher whenever these directional patterns show up. It all depends on your preferred length of investment, long-term or short-term.
Momentum Trading Indicators
Unlike basic trading strategies, momentum trades focus on price action. Regardless of whether that’s a hike or a plummet.
And that is exactly why the momentum trading strategy would be impossible without these trading indicators. These technical analysis tools allow them to track price fluctuations and determine when to enter and exit the market.
Allow us to introduce you to a couple of momentum trading indicators.
Starting off with the Momentum Indicator, which, you’ve guessed it, is the most commonly used technical analysis for this strategy.
The Momentum Indicator is an oscillator. Its single line moves along a centerline of zero or a hundred. It compares the previous closing price to the most recent closing price. Doing so allows investors to identify the strength of a trend or confirm it.
Another would be the ever-famous Relative Strength Index or the RSI. This is a range-bound indicator that signals overbought and oversold values. These are buy and sell indications. Anything below 30 is a buy signal, and anything above 70 is a sell signal.
The multitype Moving Averages are also ideal for momentum trades. These allow investors to spot emerging trends that are highly beneficial for this strategy. It also signals when the market is trending and if the said trend is accelerating.
And lastly, the Stochastic Oscillator. It is a leading indicator that predicts price movements by comparing recent closing prices to the previous trading range. And it focuses on the speed and momentum of the market instead of the volume and volatility.
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How to Start Momentum Trading
Now that you have enough knowledge about momentum trades and momentum trading indicators allow us to teach you how to use this strategy.
The very first step in learning any investment strategy is always to identify the asset or security you want to invest in. In this case, you’ll be choosing from the many momentum stocks in the trading market.
Once you’ve chosen, you will now devise a momentum trades strategy.
How exactly will you get in these momentum trades?
Through technical analysis, of course!
Remember earlier when we discussed how the momentum trading strategy would be impossible without trading indicators? We’ll prove that to you right now.
The trading indicators we discussed above are just a couple of the widely used ones. There are thousands more out there to choose from. Different kinds, different purposes, and different processes.
The trading indicator you will choose and end up using will define how your strategy will go.
That’s because each indicator provides different signals. A couple of these are trend signals, buy and sell signals, and market enter and exit signals. So, whichever your indicator signals are what you’ll focus on during your momentum trades.
You may perform a hands-on trading practice with the use of demo accounts to avoid risks. Use your demo account for as long as you need. Research and observations have also proven themselves to be beneficial while learning the process.
Once you’ve got the hang of it, you’re welcome to enter the global trading market. Best of luck!
Risks and Drawbacks of Momentum Trades
No matter where you go, there will never be a perfect strategy with no downside at all.
And that is not because there hasn’t been a great one invented yet. But because all strategies have their purposes that may not align with every investor’s ideals.
A strategy that is highly beneficial to one trader may be extremely full of disadvantages to another. It all depends on your preferences and needs.
Let’s discuss the risks and drawbacks of momentum trades. This will help you figure out whether this strategy is for you or not. Keep in mind that these factors we are about to discuss may or may not be such a downside to you due to their objectiveness.
The first one would be its high turnover. Although beneficial, most traders avoid high turnovers due to their costly fees. Most professional traders manage to find their way out of this. But it still is a common disadvantage to newbie traders.
Momentum trades are also time intensive. Which almost all investors dislike. When using the momentum trading strategy, investors are required to constantly monitor the market’s details. The more often they monitor it, the more effective the strategy becomes.
This is a disadvantage since not all traders have a lot of time on their hands. It also requires regularity. Which imposes huge risks on their investments when they fail to do so.
And lastly, advanced momentum trading strategies are market sensitive. This is exactly why this strategy is ideal for bullish (rising) markets. Because you get the chance to herd more. But in bearish (downward) markets, you’ll find your investments to shrink.