If you’ve ever considered entering the trading market, you may have heard people dissuading you and telling you that it is a gamble. While they are not wholly wrong, they aren’t entirely right either. Sure, your luck plays a role in the outcome of your investment, but there are several additional factors and trading strategies you can leverage for a fruitful return on investment. Once you learn these trading strategies, you can master the art of market investments. Let’s find out what momentum trading is, and the critical factors involved in implementing strategies for it.
What is momentum trading?
Momentum trading is defined as the practice or act of buying and selling trading market assets, as per their recent price trend strengths. The practice assumes the premise that if enough force is applied to a price move, the price will continue moving in the same direction. Assets start attracting more attention from investors and traders upon reaching a higher price, which, in turn, pushes the price to higher heights. This trend continues until numerous sellers enter the market. Once there are enough sellers in the market, the momentum strategy is said to be in force, causing the momentum to change its direction, and forcing the asset’s price to reduce.
How do traders implement momentum trading strategies?
Momentum traders attempt to identify the strength of a trend in a given direction. Once this happens, they open a position, hoping to gain from the expected change in the asset’s price. They then close the position when the trend begins losing its strength. Momentum traders primarily focus on the main body of the move of the price instead of attempting to find or analyse the top and bottom of a given trend. Their primary objective is to exploit the market sentiment and the herd mentality, i.e. the general tendency among traders to follow a proven concept and benefit from it.
Factors involved in implementing a solid strategy
The momentum trading system is primarily based on three key factors, based on which strategies are implemented. They are as under
1. The volume of the assets traded
In terms of momentum stock trading, the volume is defined as the amount of the asset traded, in a specific time frame. It represents the total number of assets traded as opposed to the total number of transactions. As such, if ten buyers buy one asset each, it appears the same as if one buyer has bought ten of the same asset. Volume, in momentum trading, is rather crucial as traders should be able to take rapid entry and exit positions. The positions they take depends on the presence of a steady number of buyers and sellers. A market with a high number of traders is known as a liquid market, in which traders can easily exchange assets for cash. If there aren’t enough traders, the market is deemed illiquid.
2. The volatile market conditions
In the momentum trading system, traders consider volatility as their primary source of income. Volatility represents the degree to which an asset’s price changes. A highly volatile market represents the presence of a significant price swing, whereas low volatility means that the market is comparatively stable. In momentum trading, traders attempt to seek out volatile markets and take advantage of the rise and falls in the asset’s price in the short term. These traders attempt to capitalise on the volatility of the asset’s prices. Since volatility represents risks, momentum traders typically implement risk management strategies to protect their trades from the volatile market movements, including setting the stop-loss limits.
3. The timeframe of the trade
The final factor involved in implementing a water-tight strategy is the total time taken to enter and exit a trade. Most momentum trading strategies focus on short-term movements in asset prices. However, how long a trend lasts entirely depends on the duration taken by the trend to maintain its strength. The time frame strategy is ideal for traders who choose to employ a longer-term trading style, for instance, position trading. Short-term traders can also combine this strategy with other strategies such as scalping and day trading.
As a market trader, you can always benefit from having multiple strategies up your sleeves. It would help if you also familiarise yourself with the various trading indicators such as the Momentum Indicator, the Relative Strength Index (RSI) Indicator, Moving Averages Indicator and the Stochastic Oscillator Indicator. You can also identify the assets you may be interested in investing and practice trading on various online simulators before you start trading live. For more details on momentum trading, you can contact an Angel One Expert.