Momentum trading strategies
Momentum trading is a technique where traders buy and sell financial assets based on recent price trends, aiming to capitalize on upward or downward movements until the trend weakens.
This strategy focuses on price movements rather than fundamental factors like company growth or economic indicators. Popular among short-term traders, momentum trading involves analyzing historical trends and using technical analysis. However, due to market volatility, prices can change unexpectedly. Events such as news releases and macroeconomic shifts are crucial factors in developing a momentum trading plan and risk management strategy.
How to Use This Guide
This guide is best used by practicing these strategies in real scenarios to find the most effective approach for your style. A demo account with £10,000 in virtual funds on our platform is a risk-free way to start exploring momentum trading. Get your free demo account.
Once you’ve identified a successful strategy, consider transitioning to a live account to apply your trading edge in real markets.
What is Momentum Trading?
Momentum in trading reflects the speed of price changes for an asset, heavily influenced by market volume and volatility. Momentum traders typically favor highly liquid markets, such as forex or stocks, which are volatile enough to allow short trades with price swings. This resembles other short-term methods, such as day trading.
Trend Following vs. Momentum
Trend following also identifies patterns on price charts. Both trend following and momentum strategies focus on price action, aiming to buy during uptrends and sell during downtrends. However, momentum trading often integrates fundamental analysis to make predictions, while trend followers focus mainly on price movement, managing position size to limit risk rather than investing large capital in a single trade.
Momentum Trading vs. Swing Trading
Momentum trading follows existing trends, while swing trading capitalizes on price ranges by buying and selling at support and resistance points. Swing trades usually last a shorter duration, while momentum trades can extend based on the trend’s strength. Unlike momentum traders, swing traders do not typically consider fundamental factors that could impact trends.
Momentum Intraday Trading
In momentum trading, timeframe is key. Although some traders hold positions long-term, intraday trading suits momentum strategies well. The goal of day trading is to quickly enter and exit multiple positions throughout the day to profit from small price changes, requiring assets with high volume for quick transactions.
A range of at least $5 per asset is typically profitable for intraday momentum trading. Smaller price shifts are ideal for scalping, common in forex markets where currency values fluctuate by “pips.” Learn more about forex scalping here.
Momentum in Stock Trading
Momentum strategies are most effective in volatile markets with frequent trading, like the stock market, where prices fluctuate due to factors like company earnings, P/E ratios, and mergers. Conducting company analysis is essential in momentum-based stock trading.
Exchange-traded funds (ETFs) also support momentum trading. ETFs often track indices with momentum-driven stocks, especially large-cap stocks with consistent activity. Developing a momentum strategy for ETFs is similar to stock trading, though ETFs involve multiple assets rather than a single share.
Simple and Exponential Moving Averages (SMA and EMA)
The simple moving average (SMA) smooths past price movements to highlight trends and can be used for short- or long-term strategies. Moving averages help identify momentum entry points, especially when combined with other technical indicators.
Average Directional Index (ADX)
The ADX indicator measures trend strength. A value above 25 signals a strong trend, while below 25 suggests weakness, prompting many momentum traders to avoid trading. High peaks indicate rising momentum, while smaller peaks often signal a downturn, suggesting an exit point.
Moving Average Convergence Divergence (MACD)
The MACD indicator identifies bullish or bearish trends. By tracking short- and long-term moving averages, MACD indicates trend strength. Greater separation between the two lines suggests a strong trend, while convergence may show trend weakness.
Momentum Oscillator
The momentum oscillator compares current and past closing prices, helping traders gauge an asset’s overbought or oversold status. As a leading indicator, it provides buy and sell signals, ideal for anticipating market moves before entering a position. Learn more about leading vs lagging indicators here.