Momentum Trading Strategies – Complete Guide
Momentum trading is the simple application of Newton’s law that an object in motion will stay in motion. Another way of saying it is that “the trend is your friend.” Momentum trading strategies are great for stocks as well as Forex and can also be effective day trading strategies.
What is Momentum Trading?
Momentum trading is the buying and selling of an instrument based on the strength of the trend in price. Momentum traders use indicators like volume and a certain class of technical indicators called momentum indicators. While momentum trading has been around since the 1700s, it really took off in the 1930s as the luminaries of technical analysis Jesse Livermore and Richard Wycoff realized the power of trading strategies based on momentum.
What Are Some Good Momentum Trading Strategies?
One very popular Forex momentum indicator is the Williams %R indicator. The Williams %R has a value ranging from -100 to 0. -100 indicates that the instrument in question is oversold, suggesting a possible buying opportunity. When the Williams %R nears 0, it indicates an overbought market. This suggests that it is a good time to sell the instrument. Here are some good momentum trading strategies that you can use to add momentum-based trading strategies to your trading toolkit.
A Momentum Strategy Using Williams %R
- When you identify an uptrend (defined as higher highs and higher lows), then wait for some bullish signal. This could be a candle pattern or a divergence between the market and the RSI or the market and the MACD indicator;
- Once you identify an uptrend and confirm its strength with a bullish signal, wait for the %R to show oversold. This is generally taken to be -80% or below. At this point, wait for the Williams %R to rise back at or above -50%. At this point, you want to buy;
- You want to set your stop loss at the most recent higher low and set your take-profit point as a trailing stop at the most recent higher low.
EMA Momentum Strategy
The Williams %R is rather simple enough to use but another popular momentum indicator is even simpler. These are moving averages. A simple, but effective momentum trading strategy can be formed from the 20-period EMA and the 50-period EMA.
- When the 20-period EMA crosses above the 50-period EMA, then the instrument is in an uptrend and the pair is ready to buy;
- If the 20-period EMA crosses below the 50-period EMA, then we are dealing with a downtrend and the pair is ready to sell.
You can combine this signal with other candle patterns or indicators for more confirmation before you make a trade. More conservative traders will wait for the EMA to close above or below the slower EMA (50-period) before committing to a trade.
It is wise to pair momentum signals with other class of signals, such as support and resistance, volume and volatility. If you only look at momentum indicators, they are all telling you the same thing and using the same underlying principles to do it. Using indicators with different underlying principles improves your strategy because you are looking at it from two different ways and not just the same way multiple times.