Momentum trading is great for short term traders, typically those trading at expiries of 15 minutes or less. Basically, it looks at the direction that an asset is moving and the strength with which it is moving—its “momentum.” Using this strategy involves an understanding of how to create and interpret technical indicators, but once this hurdle is overcome, it is a quite powerful trading strategy.
Let’s get started.
The first step is to pick an asset and create a chart of it. This should only take a few minutes to set up. The asset you choose should be familiar to you so that you can better anticipate unexpected issues that a simple momentum technical strategy will not reveal.
Once you’ve created a chart, it’s time to put some indicators on that chart. You need to have a fairly advanced charting package to do this, and the chart needs to update in real time. Some brokers will provide these for you free of charge, but you will most likely need to find one online or purchase a package yourself. These are pretty cheap, and they are well worth the investment as it opens up a lot of new trading opportunities for you.
Picking the right technical indicators to use is important. We like the MACD indicator because it gives a few different pieces of information all in one spot. MACD stands for Moving Average Convergence/Divergence, and it establishes two baselines to go along with the price chart. These baselines show the momentum that has been established over two different timeframes. When used together and put up against the price line, you will now be able to see what the current price looks like in comparison to past movement. As a general rule, assets like to act like they’ve usually acted like. So if you see the momentum getting away from the baselines, then you can expect that it will return back to normal soon. An opposite position can be created to reflect this.
It will take some time playing around with different indicators to figure out which works best for you and the particular trades that you will be making. For example, some people like using simple moving averages and putting them up against exponential moving averages to help them establish past momentum and put it in reflection against more current movements, giving the most recent events more weight. What you decide is up to you.
Things to Look Out For
Like all strategies, momentum trading can have its fair share of issues. For one, momentum indicators take past occurrences and try to predict the future. While this often works, when external events happen that have an impact on price, it can stop working. We suggest using a streaming news service so that you can keep tabs on your assets of choice so that you are never caught unawares by news events that nullify momentum signals. Also, having an economic calendar that reflects your assets’ upcoming events can alert you to important dates and times that may cause issues for your trading. These can also let you know when other strategies and trading opportunities will arise.
Finally, we encourage you to use this strategy along with other ones. By itself, momentum indicators can be helpful, but they work best when the same trades are confirmed by another method. This will take some time for you to develop, and as you become more familiar with chart interpretation, this aspect of things will become a lot easier for you to do. When done correctly, having two indicators is better than one as it creates confirmation that your trade ideas are strong.