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Welcome to our Trading Strategy Series, where you will get introduced to different strategies to help you trade better. In this article, we’ll introduce you to momentum trading.

What is Momentum Trading?

The dictionary defines momentum as: “the strength or force gained by motion or through the development of events.”[1]

This concept has profound implications for traders, who are constantly trying to get on the right side of momentum. After all, success often boils down to buying an asset when its price is accelerating.

In momentum trading, traders focus on assets that are moving significantly in one direction. These assets typically exhibit higher trading volumes.

How Do Traders Determine When Momentum Is Occurring?

When it comes to trading, it isn’t enough to say that prices are moving really fast in one direction. To confirm upward or downward momentum, traders rely on various technical indicators. These indicators provide confirmation that an asset is currently experiencing momentum.

Momentum indicators use various formulas to measure price changes. The Relative Strength Index (RSI) is one of the most popular momentum indicators. It compares the average price change of recent gains and losses over a specified time period. On the RSI chart, an asset is considered overbought if it reaches above 70 and oversold when it crosses below 30. RSI readings above 60 generally represent strong upward momentum, whereas readings below 50 correspond with stronger downward momentum.[2]

The Moving Average Convergence Divergence (MACD) is another popular indicator traders use to measure changes in the strength and momentum of an asset. On the MACD chart, an asset is considered to have strong upward momentum if prices are above the zero line. An asset has weak momentum if prices are trending below the zero line. A move above or below the line usually signals a change momentum from positive to negative or vice versa.

How to Use Momentum Indicators

Regardless of your trading strategy, you can use momentum to confirm your buy or sell points. If you believe a particular asset is going higher, you can use the RSI and MACD to confirm whether that is the case. In other words, you can use these indicators to determine the strength and durability of an uptrend. If you are looking to sell an asset, you can also rely on these indicators to confirm that momentum is declining.

A strong understanding of momentum can make you more adept at various trading styles. By looking at momentum, you are better able to visualize the strength of price movement and anticipate possible corrections and trend reversals. This can be your launching pad to more successful trades in the future.

[1] Ian Harvey. Momentum Traders. Investopedia.
[2] Stockcharts. Introduction to Technical Indicators and Oscillators

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