Momentum trading is a strategy that aims to take advantage of market volatility. Of course, volatility can be a fearful subject for newbies in the world of trading. But in this article, we’ll tackle why it’s actually a good thing for momentum traders. Let’s start.
What is Momentum Trading
Basically, momentum trading is taking short-term positions in assets that are going up and selling immediately once you see any signs of a fall. You then move your money to a different position.
You can then imagine the market as an ocean, and its moves as waves. You try and ride the wave as it goes up, and then switch to another wave before the current wave plunges.
If that’s not clear enough, momentum trading basically lets you take advantage of investors’ tendency to herd. You lead the pack, and then you leave to take the money and run before the group collapses.
Risk Management in Momentum Trading
Risk management plays a huge role in momentum trading. That’s not surprising since momentum traders primarily deal with volatility.
To perform momentum trading with enough risk management, you need to carefully choose the asset you’re going o trade. Choose a liquid security—that’s the rule.
Timing is also crucial. Be careful not to jump in a position too soon. And ‘too soon’ means the momentum of the asset price is not yet certain. Also, avoid closing the position too late. And here, ‘too late’ means reaching saturation.
Another factor in timing is distraction. Things happen. For instance, you take your eyes off the monitor for a few moments at a crucial point, and when you look at it again you see that the direction of the market has totally changed.
Of course, momentum trading isn’t popular for no reasons at all. Traders using momentum investing enjoy the following advantages.
Quick High Returns
You can make a lot of profits using momentum investing . In a long-enough timeframe, your profit potential increase with this strategy can be huge.
Volatility becomes Your Friend
As we have previously mentioned, dealing with volatility is what you do in momentum investing. Your goal is to capitalize on market trends to find assets on their way up and lock in profits before they go down.
Momentum traders chase performance in a very systematic way. They find specific buying points and selling points.
They do not depend on their emotions to respond to certain market movements. Instead, they follow the strategy built around momentum.
You can even say that momentum traders take advantage of other investors’ emotional decisions.
Is Momentum Trading for You?
Momentum trading is a legitimate market strategy. However, it doesn’t work for all investors. This strategy practically bugs out beginner investors.
That because, for instance, if you do momentum investing as your primary strategy, you’re reacting to old news. Other investors who group together already are ahead of the curve.
The best thing to do is try momentum trading when you’re already sure you have enough market knowledge and experience.