Forex and stock trading markets have long remained a profit-generating source for traders and investors. These markets see trillions of dollars of average trading volume daily, stressing the significance of this domain.
Moreover, traders constantly look for strategies that could enable them to procure maximum benefits from the price movements. Successful traders utilize various technical indicators, charting patterns, and techniques to exploit the market sentiment and price flow.
The momentum trading strategy is among the most commonly utilized forex approaches among traders. It allows market participants to ride the trend and catch volatile price action within a short duration.
Read this article, as we have reviewed the specifications of this strategy along with trading setups examples.
What is a momentum trading strategy?
Such trading involves the buying and selling of financial securities based on the strength of their price action. Momentum traders identify a trend’s force and strive to capitalize on that price flow.
By implementing this approach, technical traders benefit from the market price action and specify their entry and exit points. It is important to note that momentum strategy is not one defined and fixed technique; instead, it can involve diverse techniques that profit from price movement and market volatility.
Moreover, momentum traders do not look for trend reversals and beginning points. In contrast, they place their trades in the direction of an ongoing strong wave until it shows signs of conclusion.
How to determine the price momentum?
Momentum trading strategies pivot around the fact if the price shows significant strength at a trend’s beginning, it would most likely continue in that direction for some time. Determining the instances of solid momentum is of utmost importance to profit from this trading strategy.
The two key factors that indicate the momentum are:
- Market volume
A price trend in a liquid market with high trading volumes serves as an excellent signal to momentum traders. Moreover, volatility allows momentum traders to profit from wild price swings.
Fundamental factors and economic data are less pertinent to momentum traders as they rely on price action and technical analysis tools. These traders detect momentum using numerous technical indicators such as stochastic RSI, relative strength index, MAs, a momentum indicator, and MACD.
The oscillating indicators like RSI and MCAD plot a separate chart showing the overbought and oversold areas. On the other hand, overlying indicators like moving averages assist traders in identifying developing and ongoing trends.
Momentum trading example
We will discuss two momentum trading examples with a bullish and bearish setup. In this strategy, we have utilized three technical indicators:
Bullish trade setup
The above XAU/USD chart displays a bullish momentum trading setup in a 15-minutes time frame. As a first step, we will identify the prevailing trend. We have applied 60-period smooth and 50-period exponential moving averages to confirm the ongoing trend and detect any emerging trend.
After a MAs cross-over, the market appears to be ranging above both moving averages, which specifies a bullish trend.
Secondly, we will establish the strength of the price move. The consecutive big green candles at the left-down corner confirm the beginning of a strong momentum move. As a momentum trader, we would follow this forceful uptrend.
Here the most suitable buy entry position would be when the price bounces from the moving average support and MACD turns negative. A reasonable stop loss position would be below the bullish momentum candles.
This momentum trading setup offers a good R:R ratio of 1:3 to 1:4. Our TP1 would capture about 80 pips, whereas the TP2 placement would be at 150 pips from the entry point.
Bearish trade setup
The above GBP/USD chart shows a bearish momentum trading example in the 15-minutes timeframe. We have utilized two moving averages, namely 60-SMA and 50-EMA, to specify the trend direction. In this case, the price is moving below the moving averages, confirming a downtrend.
Next, we have confirmed a strong bearish momentum by the appearance of long and consecutive red candles. Our strategy would capitalize on this bearish trend, predicting that it will continue for some time.
The ideal sell position would be on the price bounce from the moving average resistance and when the MACD turns positive. The stop loss placement would be just above the bearish momentum candles.
This momentum strategy provides high reward trades. Our first take-profit point would capture 30 pips, whereas the TP2 would be 50 pips below the entry point.
Is the momentum trade strategy profitable?
Momentum trading can provide enormous profits quickly; however, it involves high risks due to market volatility. Momentum trading is not a practical option for long-term and emotional traders. This strategy is only profitable for ones who own sharp technical analysis skills and follow their defined rules.
It takes substantial expertise and discipline to ride strong trends by entering at ideal points. The key to momentum traders’ success is capturing the market flow; instead of going against it. They capitalize on the “trend is your friend” saying but only ride with a “powerful” price flow.
As a result, momentum traders can acquire massive gains if they show marked attentiveness, diligence, and acuity.
Pros & cons
Momentum trading is an efficient and effective trading strategy; however, it also has certain constraints.
Traders utilize basic technical indicators and analyze price action to generate profits. There is no involvement of complex fundamental analysis.
A momentum trader needs to monitor the markets constantly for grabbing suitable opportunities.
|High gains in short duration|
Momentum traders obtain remarkable gains on par with swing traders in a short duration of days or weeks.
|Volatility risk |
Momentum trading capitalizes on volatility, which is a risky feature if it goes against you.
Momentum trading has a higher success percentage as it involves riding the dominant trend.
|Sensitive to market sentiment|
Any sudden shift of market sentiment can disturb the ongoing trend, rendering technical analysis worthless.
Many profitable trading strategies based on price momentum have become common among day traders. The high-reward momentum techniques allow traders to obtain massive profits within a single day or week.
However, the opportunity to seize enormous gains comes with substantial challenges. Momentum trading is time-sensitive and requires a sharp reaction to counter market volatility. Moreover, traders need to have a keen eye for examining price action strength and fading trends.