What Exactly Is Momentum Trading and How To Use It Effectively

The fundamental is that you will not buy stocks at their lowest, nor will you sell them at their highest. If you do not buy a stock until you see it rising, that means you have missed your opportunity to buy it at its lowest. Similarly, if you do not sell a stock until you see it falling, you have missed your opportunity to sell it at its highest.

The primary technical indicator is the momentum indicator, i.e. the accumulated net change of a stock’s closing/ending price over a series of defined time periods. The momentum line is plotted as a tandem line to the price chart and it displays zero axis. The positive values indicate a sustained upward movement and negative values indicate a potentially sustained downward movement. The upward or downward momentum indicator portrays a "breakout" for the stock.

When the trader believes he has identified a breakout, missing the first one or two breakout ticks doesn’t matter as he has his hand on the buy trigger (or sell trigger in the case of a short sale) for one of the next momentum periods. And he is generally not too concerned about hitting the bid either, as he will have an easier time getting in at the market price. Then he places a market order.

The graphics for the Qualcomm (QCOM: NASDAQ) illustrates what is turning individual investors into momentum traders. In the year March 2001 to February 2002, the stock rose from a split-adjusted 7 1/2 to 200. Stocks like these have created a quick-sell mentality. Recently The New York Times reported that investors hold NASDAQ stocks for an average of only five months. Ten years ago, they held a stock an average of two years. Momentum trading is also fraught with peril that can easily destroy even the most disciplined and knowledgeable trader. With a proper understanding of the technique, sufficient knowledge of the risks, and willingness to take an occasional loss, momentum trading offers an appealing choice for the aspiring trader who enjoys living on the edge.