Momentum Trading - Meaning, Process & How does it work? | 5paisa (2024)

FAQs

Momentum Trading - Meaning, Process & How does it work? | 5paisa? ›

A trading technique known as momentum investing involves buying assets when they are rising and selling them when they appear to have peaked. The objective is to manage volatility by looking for purchasing chances during brief uptrends and then selling when the momentum of the securities begins to wane.

Key Takeaways. Momentum investing is a trading strategy in which investors buy securities that are rising and sell them when they look to have peaked. The goal is to work with volatility by finding buying opportunities in short-term uptrends and then sell when the securities start to lose momentum.

A position under momentum trades can be held for a longer period, if the trend continues. In this scenario, a higher profit can be targeted. Another disadvantage of momentum trading is that it might increase the degree of risk in your portfolio.

For example, suppose you are bullish on the Indian stock market and would like to go long on stocks with solid momentum. You would first look at a chart of the Nifty index to identify the prevailing trend (upward) and then identify stocks with solid upward momentum within this broader bullish trend.

The primary benefit of momentum trading is that you can potentially make a large amount of money over a short period of time. If you buy and hold a stock, for example, even a long-term winner may have months or even years in which it doesn't move hardly at all or even trades at a loss.

Moving Average Convergence Divergence (MACD)

Often regarded as the best momentum indicator, MACD is a trend-following indicator. It represents the relationship between 2 moving averages of a financial instrument's price.

A 5-minute chart serves well for short-term momentum trades, recognising support/resistance levels, and establishing intraday trends. It provides more contextual information compared to the 1-minute charts. The 15-minute chart, a popular intraday time frame, balances capturing short-term moves and filtering out noise.

Richard Driehaus (1942-2021) is sometimes considered the father of momentum investing but the strategy can be traced back before Donchian.

What is the difference between scalping and momentum trading? ›

Scalping: The scalper is an individual who makes dozens or hundreds of trades per day in an attempt to "scalp" a small profit from each trade by exploiting the bid-ask spread. Momentum Trading: Momentum traders seek stocks that are moving significantly in one direction in high volume.

Momentum is measured by continually taking price differences for a fixed time period. To create a 10 day period momentum line you would subtract the closing price from 10 days ago from the last closing price.

The term “2-hour trading strategy” describes a time-based approach to trading in which a trader actively buys and sells financial assets within a two-hour window, usually during the hours of the market that are the most volatile. It does not refer to a specific method in and of itself.

The bottom line on momentum trading is that it is a higher-risk way to put money to work in the stock market. And it's certainly a form of trading, not investing. Momentum trading can be a good way to make money when things work out, but it can quickly result in big losses if things go the other way.

Momentum Investment Limited is not a trusted broker because it is not regulated by a financial authority with strict standards. We would not open an account for ourselves with them. If you want to stay safe, only sign up with brokers that are overseen by a top-tier and stringent regulator.

Some of the potential risks associated with this strategy include: Reversals in the market: Since trends are not permanent, there is a constant risk that the market might change direction, resulting in potential losses for momentum investors.