Momentum Trading Strategies – key points to know

Written by K T

On July 26, 2021

In order to use the Momentum Trading strategies successfully, it is crucial to determine whether a stock has fallen because of market conditions or because of bad news. It is tempting to presume that the negativelyreported stock price is a result of overvaluationand not the other way aroundbut shortterm price fluctuations may in part be the result of temporary market influences.

Key points Momentum Trading Strategies:

  • Don‘t place trades where your expectations of the direction of the stock are neutral
  • Sometimes significant changes in momentum happen on the expiration of options contracts
  • Stock can become detached from the underlying price of the stock commodity, which can lead to confusion
  • Don‘t be fooled by a quick, sudden reversal in momentum
  • Aftermarket moves may be attributed to variables outside of the stock
  • Use technicals with a skeptical mindset
  • Trade in a timely manner

Are all trading Momentum Strategies risky?

All trading is risky. This is a question for the reader

Many momentum trading strategies are not necessarily that risky. For example, if a strategy is expected to have a higher return<span data-offset-key=”1jpt9-33-0″> than the riskfree rate, it is not risky. Momentum is a measure of the rate of change in prices over a specific time interval. A momentum strategy may be profitable if prices are trending<span data-offset-key=”1jpt9-73-0″> upwards. In this case, the price of a stock is expected to continue to rise because it is on an upward trajectory. On the other hand, a momentum strategy may be profitable if prices are trending downwards. In this case, the price of a stock is expected to continue to drop because it is on a downward trajectory. Effectively, a momentum strategy may be profitable if prices are trending in either direction.

What is the advantage of momentum trading?

Momentum trading<span data-offset-key=”13rsi-39-0″> has the ability to capture the trend in stock prices, which in turn can translate to a higher rate of return. In other words: Investors know that the trend is in their favor when they are momentum traders and they have the opportunity to make a larger profit when the trend is in their favor. 

What is the disadvantage of momentum trading?

Momentum trading has the potential to lose money even if the overall market<span data-offset-key=”13rsi-89-0″> is performing well. Some investors might believe that momentum traders are wrong to assume that a trend will continue. Momentum traders need to be able to quickly respond to any changes in the trend in their investment. 

What is the most widely used momentum strategy?

The most widely used momentum strategy is trading on breakouts.

What is a breakout?

A breakout is when a stock moves past a previous level of resistance. A breakout strategy is a method of trading where a trader can identify two points on the chart. One point can be considered the ‘resistance’ point and the other point can be considered the ‘support’ point. The trader would sell on the ‘resistance’ point and buy on the ‘support’ point. It is the opposite of the “contrarian” or “value” investing style that buys when prices have fallen drastically without a corresponding change in the company. The strategy buys the stocks at what appears to be an overvalued price and sells them when they have risen to the point where they are apparently undervalued.

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