Momentum Trading: Types, Benefits, Strategies, and More

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What is Momentum Trading

Traders take advantage of market momentum to make profits, a strategy known as momentum trading. According to Newton’s first law of motion, an object in motion will stay in motion unless an external force acts upon it. A market can start on a particular price trajectory and sustain this movement within a specific time period.

What is Momentum Trading

The strategy is based on trend following and supports the idea that a trend is likely to continue until it is shown to have reversed. Though not the first person to use the strategy, Richard Driehaus is considered the father of momentum investing because he used the strategy to run his funds.


Citing statistical data, Professor Damodaran further explains that, “Momentum stocks have an average beta almost twice that of the rest of the market … and are much What is Momentum Trading more volatile.” The Relative Strength Index is a momentum indicator that measures the magnitude of recent price changes to analyze overbought or oversold conditions.

What is Momentum Trading

Some may also check investors’ sentiments and the direction of the broad market. Although some momentum traders prefer to take positions in the long-term, one of the most appropriate strategies for trading on momentum is the short-term approach of day trading. The aim of day trading​​ is to enter and exit multiple positions as quickly as possible throughout the day, with the aim of making a profit from small price movements. Therefore, momentum traders look for markets and securities with a high volume, so that they can buy and sell stocks quickly without interruption. Technical analysis is the primary point of reference for momentum investors. By employing a momentum investing strategy, investors look to profit from buying or selling short securities when they are strongly trending, i.e., have high price action momentum. A marker of high momentum is a wide range of price advances or declines in a short period of time.

Which indicator is best for momentum trading?

In studies, it has been observed that securities that have risen in recent months tend to continue to do so for a few more months. Depending on which past period was taken as a reference and how long the securities were held thereafter, a different magnitude of effect was observed. The same applies in reverse for securities that have recently fallen in value. The share price only rises gradually with a delay until the true higher value is only reached after a few months. As the trend gains momentum – strengthens – the trader takes a market position in the direction of the trend (buying an uptrend; selling a downtrend). Lower numbers, below 50, indicate a downtrend that is gaining momentum. However, an oscillator reading below 20 indicates oversold conditions in a market that may lead to a market reversal to the upside.

Is momentum trading the most profitable?

Momentum trading is a bit different than the usual value investing paradigm of “buying low and selling high”. Over the years momentum trading strategies have proved to be profitable in the financial markets. In practice, momentum trading is seen to be more popular than “buying low and selling high”.

Strong momentum can continue in an upward or downward trend, which can be confirmed by changes in trading volume and other technical indicators. The rate of change of return, as it states the return generated between two reference time period. For the sake of this discussion, let’s stick to the rate of change of return on an end of day basis.

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