Level: Experienced
Reading time: 3 min
Momentum trading is popular. Traders use it to take advantage of price momentum on a short-term basis. Though momentum trading with stocks can indeed be lucrative, it can also be a double-edged sword if you don’t prepare and manage the trade well.
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What is momentum trading?
When using the momentum trading strategy, you need to find a market that has made a clear move lower or higher. To buy, what you’re looking for when the price has gone considerably higher. You then use this price-hike momentum to make a profit as you expect the momentum to continue making the price rise.
You can see in this example chart that the price is moving quickly higher. This would be a good time to buy when prices are on the rise.
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Momentum trading over the short-term
Lots of traders use momentum trading with intra-day trades. This means they use time frames as small as five minutes or fifteen minutes. The fact you can enter and exit trades so quickly is a reason why this is so popular.
There are heaps of trading opportunities when you decide to trade 15-minute charts as the trends change really quickly.
Momentum breakout
To find a momentum setup, you can either use an indicator or look for momentum breakout. A momentum breakout occurs when the price has moved lower or higher already quite strongly. Then, the price consolidates and moves often into a box formation. When the box breaks, the trader looks to trade in the momentum direction.
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Let’s see an example:
The price has moved higher then paused and moved into a box. It has then broken out higher again and the momentum has continued.
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What is the indicator for momentum trading?
A popular (if not the most popular) indicator for momentum trading is the moving average. This can show when trends are forming as well as when there is a strong momentum building.
Momentum trading examples
In all markets, traders want to enter a trade at the best price. Momentum trading is the same. Many traders simply want to see when a price pulls back into a demand or supply zone with momentum.
The first step is identifying the strong momentum. Then, you look for a higher pullback to find a good entry point.
The example below highlights a below-price pullback into resistance. This is a potential entry point when the momentum is lower.
The chart highlights this, showing the strong move lower.
Final thoughts on momentum trading
Momentum trading is often lucrative when it’s done correctly. Lots of traders use the strategies listed in this article alongside their other tools and techniques for finding entry points with a high probability. Some of these other strategies used are price action clues, and Japanese Candlesticks.
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