Momentum trading is all about harnessing the power of upward or downward trends in stock or ETF prices. With the mantra “the trend is your friend,” momentum traders capitalize on the momentum already driving prices in a particular direction.
Spotting Highs:
Successful momentum traders focus on stocks and ETFs that consistently climb in value, often reaching new highs day after day, week after week, and sometimes even for several months. While some investors may hesitate to enter markets at new highs, historical evidence suggests that markets making new highs often continue to rise further.
Managing Volatility:
Momentum trading comes with heightened volatility compared to other strategies. Traders must navigate this volatility carefully, as mistimed trades can result in significant losses. Many momentum traders use stop-loss orders or other risk management techniques to mitigate losses in unsuccessful trades.
Identifying Trends:
To find the best-performing stocks and ETFs, momentum traders often look at metrics like the percentage of assets trading near their 52-week highs or the percentage price change over the last 12 or 24 weeks. Shorter-term price change measures, such as 1-week or 4-week changes, can help identify trends early on, aiding both entry and exit decisions.
Steps to Success:
To excel as a momentum trader, you must swiftly and accurately identify the strongest sectors. This can be done manually or with the help of screeners, following these steps:
- Identify stocks and ETFs of interest.
- Determine the number of assets trading near yearly highs.
- Rank the chosen assets from highest to lowest performance.
- Develop an entry strategy, whether it’s entering on short-term strength or buying during pullbacks.
- Establish an exit strategy, outlining when to take profits and when to cut losses.
Understanding Risks:
It’s crucial to recognize the risks inherent in momentum trading. Relying on recent buying activity by other investors carries no guarantee of continued upward momentum. External factors like news developments or profit-taking by existing holders can swiftly reverse momentum, leading to losses for momentum traders.
By mastering the art of momentum trading, investors can ride the trend to success while managing the inherent risks of this dynamic strategy.
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