- Momentum trading is an investment strategy where traders acquire raising or falling financial assets and liquidate them before they have peaked or bottomed out.
- Momentum strategies are prevalent in day trading with high-volume securities, including forex pairs and metal commodities.
- Traders learn how to use market volatility, leverage, and fast execution to potentially profit from newly formed market momentum.
- The principal risks of momentum trading strategies are associated with traders moving either too fast or too late to capture significant profits.
- Benefits of momentum trading include potential short-term, but high profits and the opportunity to leverage the market’s volatility to do so.
Momentum trading is a well-suited strategy for high-volume markets such as forex and metal commodities. Traders can take advantage of forming price momentum and potentially earn profits. The underlying motto is to buy high and sell higher or buy low and sell at the bottom. Momentum trading is an intraday strategy. At first, it may sound like a reflex reaction more than a coordinated and thoughtful execution. However, traders can use technical indicators and news catalysts to identify a new momentum. When executed well, Momentum Trading can lead to quick and fruitful profit-taking, usually faster and more lucrative than other forex trading strategies.
What is Momentum Trading?
Momentum Trading is a relatively new strategy. The history dates to Wall Street in the 1990s when the S&P500 index moved rapidly and clearly. The market would be either bullish or bearish. Richard Driehaus and other trading gurus realised that they could profit following the momentum. Instead of discovering under-priced assets and waiting for a market correction, these trading stars would find volatile assets and ride the wave. Unlike the conservative strategies, Momentum Trading resembles surfing. Investors ride a wave until its peak and then crest another momentum, repeating a similar maneuver. It is a game of skill and focus because it relies on volatility and fast execution. The strategy seems illogical at first and truly challenges the typical trading psychology. It defies the age-old Wall Street principle of “buy low, sell high.” Momentum Traders bet on already formed trends, buying and liquidating positions within a short period, usually the same day. Forex traders can identify momentum opportunities using technical indicators, market-moving news, and sentiment. Some of the most popular technical indicators include moving averages (EMA and SMA), relative strength index (RSI). Economic calendars highlight potential market-moving news. We have described these in detail further below.
Essential Elements of Momentum Trading Strategy
Momentum Traders know their risk appetite and follow careful rules to avoid potential pitfalls. Volatility, overly traded territories, and hidden traps can sink a position if the trader loses control at any time. Traders always keep an eye on certain aspects, but this can slightly vary depending on personal risk appetite:
- Assets liquidity
- Trend momentum
- Entry timing
- Exit point
Momentum Traders execute bets precisely. Otherwise, traders risk losing control and getting stuck in the wrong position. The main goal is to identify the direction of the market rally and ride the wave of volatility. Suppose USD/EUR shoots up unexpectedly and breaks resistance barriers. In that case, momentum traders can see it as an opportunity and crest the wave, liquidating the position right before the pair starts losing steam. Timing is the cornerstone of Momentum Trading. Make sure to identify entry and exit points.
What are the Best Momentum Trading Strategies?
Momentum Trading is well-suited for intraday strategies. It is popular with liquid assets— including stocks, commodities, and forex markets. Momentum traders generally tend to avoid ETFs and Index funds because these securities usually move at a slower pace and offer less volatility. Momentum Trading strategies need volatile price swings and high liquidity.
1. Technical Intraday Momentum Trading Strategy
Traders use one or several technical indicators to identify a trend formation. Moving averages and momentum oscillators are among the most popular technical indicators in forex momentum trading.
Momentum Technical Indicators
- Relative Strength Index (RSI). It is an oscillator used to calculate whether a trend is accelerating or decelerating, hinting at a possible trend change.
- Moving averages (SMA and EMA). Forex traders use moving averages to calculate both short-term and long-term market trends.
- Average directional index (ADX). Traders use the ADX indicator to measure when a trend is gaining or losing momentum.
- Moving average convergence divergence (MACD). This oscillator uses two moving averages to identify whether a trend formation is bullish or bearish.
- Momentum indicator. This oscillator calculates if a currency pair is overbought or oversold, helping traders gauge momentum strength.
Oscillators are trading tools with a centerline that oscillates between two values — usually between 0 and 100. Rakuten Securities Australia offers all momentum trading indicators within the MT4 app. Traders can try their luck with a demo account today, trading fictive money in forex markets. Demo account helps investors fine-tune momentum strategy before investing real money.
2. News-Driven Momentum Trading Strategy
Economic news can prompt rapid price swings. Momentum traders can identify news that triggers volatility in a market or currency pair. Traders that execute positions following the news release can be rewarded with instant profits. Potential news shocks are usually flagged in most economic calendars. These generally include speeches, announcements, and reports.
- Political Speech. Governors, presidents, and central bank chairpeople can shake markets with their words. If FED’s chairmen suggest raising interest rates, the market can respond with a volatile price swing.
- Inflation data. Consumer Price Index (CPI) is the primary way the market measures inflation. CPI measures price change in a basket of goods and services, hinting at possible interest rate change and unhinged inflation.
- Central Bank meetings. Central bank meetings of all kinds can trigger volatility in forex markets, including meeting minutes and interest rate announcements. Central banks have a direct impact on the price of money. This news can trigger unexpected and massive price swings.
- Gross Domestic Product (GDP). Countries with rising and robust GDPs typically install a positive outlook among investors. Traders use GDP as the essential gauge to measure the strength of an industrialised economy.
- While unemployment is measured with different reports and indicators, the US Non-Farm Payrolls is the most influential market-mover in America. These reports show monthly changes to how many people were employed, excluding farming jobs, as the name suggests.
Economic calendars help forex traders stay on track with the abundance of market-moving news. However, forex market news is unpredictable, prompting most traders to execute stop-loss and take-profit orders with every investment.
Start Trading on Forex Momentum
Forex traders first need a broker before they can start trading. Sign with a trustworthy service to avoid unexpected risks. Rakuten Securities Australia offer superior liquidity, instant execution, education content, and everything you may need to start buying and selling the momentum. If you are not ready to invest real money just yet, open a demo account where you can invest virtual cash in a risk-free environment and hone your skills as a trader. Both new and experienced investors practice with a demo account to curb risks, save money, and get a feel for the markets. Demo accounts are free and take less than a minute to start. Apply today.