So much about trading sounds a lot more complicated than it is.
For the most part, it’s all about buying as asset at a lower price than you sell it. But knowing when to do both of those things is where it gets tricky.
Momentum trading can help in that regard, as it can point you toward when to buy and sell according to the strength of recent price trends. Price momentum is similar to momentum in physics, where mass multiplied by velocity determines the likelihood that an object will continue on its path.
A car traveling down the road at 65 is likely to continue moving forward at any given moment, while one sitting still can just as easily go forward or backward.
It’s a clunky analogy, I know, but you get the idea.
The good news is that momentum trading is about as old as the stock market itself, and the pioneers of market technical analysis left us with four driving principles of market dynamics that still guide technical trading decisions today.
Momentum trading is also one of the most proven ways to trade. So much so that Roger Scott, an expert trader that designs systems, usually includes momentum as one of the factors he looks at before trading any stock.
Now, let’s take a look at the four keys of momentum trading.
#1: A Trend is More Likely to Continue its Direction than to Reverse
With price established in a clearly defined trend of higher highs and higher lows, certain key strategies and probabilities begin to take shape. Once a trend is established, it takes considerable force and capitalization to turn the tide.
Fading a trend is generally a low-probability endeavor, and the greatest profits can be made by entering reactions or retracements following a counter trend move – and playing for either the most recent swing high or a certain target just beyond the most recent swing high.
An absence of chart patterns or swings implies trend continuation until both a higher high and a higher low (opposite for uptrend changes) form and price takes out the most recent higher high.
#2: Trends End
Trends continue in “push/pull” fashion until some external force exerts convincing pressure on the system, be it in the form of sharply increased volume or volatility. This typically occurs when we experience extreme “continuity of thought” and euphoria of the mass public (that price will continue upwards forever).
However, price action – because of extreme emotions – tends to carry further than most traders anticipate, and anticipating reversals still can be financially dangerous. In fact, some price action becomes so parabolic in the end stage that up to 70% of the gains come in the final 20% of the move.
Markets also rarely change trends overnight; rather, a sideways trend or consolidation is more likely to occur before rolling over into a new downtrend.
#3: Momentum Beats Price
What I mean when I say that momentum leads price is that new momentum highs have higher probability of resulting in a new price high following the next reaction against that momentum high. Stated differently, expect a new price high following a new momentum high reading on momentum indicators.
A gap may also serve as a momentum indicator. Some of the highest probability trades occur after the first reaction following a new momentum high in a freshly confirmed trend.
#4: Price Alternates Between Range Expansion and Range Contraction
As a rule, price tends to consolidate much more frequently than it expands. Consolidation indicates equilibrium points where buyers and sellers are satisfied and expansion indicates disequilibrium and imbalance between buyers and sellers.
It is often easier to predict volatility changes than price, as price-directional prediction following a low-volatility environment is almost impossible. Though low volatility environments are difficult to predict, they provide some of the best risk/reward trades possible.
Those are the rules. Now, how do you take advantage of them? Well, here’s the easy way.
My good friend Roger Scott has built a system that looks at momentum, volatility and eight other critical stock factors. He studied stocks that make large, unexpected moves higher and reverse engineered what factors they have in common.
He found that the stocks usually shared 10 factors in common, and he built a system around those traits. And the returns have been incredible, he’s often able to capture triple-digit gains in days…
Best of all, he’s about to alert his latest trades. If you want to receive his next batch of trades, just let him know.