Momentum Trading

In market terms, momentum is a measure of the velocity of a change in price.  Momentum trading is often used to describe the short term application of trading decisions that accompany periods of high velocity of price change in the markets.  The anticipation of a change in momentum in the markets or for a particular security is often a result of signals from technical indicators or changing fundamentals.  It can be event related or tied to a response of global changes.  The key focus for Momentum trading is the integrity of the price trend segment that is being traded.  While the trend remains intact, traders organize trading strategies based on the current trend and assessment of whether that trend will remain in place over the forecasted period of the trade.  A key focus point is on any indications that a reversal of price trend may occur.  This may include trendline breaks, changes in underlying fundamentals as well as critical day analysis, which is a forecast put out by Trade10.com of potential reversal points for the major U.S. indices with respect to the short segment price trend (3 to 5 day price trend.)

When anticipating a price trend reversal, a trader is expecting markets that are falling to reverse and head higher and vice versa.  There are a number of early identification tools that can be used in developing a sense for when price trend reversals are most likely to occur.  There are also a number of supporting forms of evidence that help a trader develop a confidence and price projections when a reversal of price trend is suspected.   Some of the technical studies to the right discuss aspects of trend reversal and momentum changes.  Our own critical day is an expectation of a reversal of the shortest segment of price trend for the major U.S. Indices.  Below is a chart of the S&P500 Index.  The dots on the chart were provided to members on average 3 days in advance of the date.  These dots indicate critical days which are points in the market path when a reversal of the short segment of price trend has a higher probability of occurring.

When the flow of candle bodies rises leading into the critical day, the expectation is a reversal of that trend and for the flow of candle bodies to fall coming away from a critical day. When the flow of candle bodies falls leading into a critical day, the expectation is a reversal of that short trend and for the flow of candle bodies to rise coming away from the critical day.  There are some special circumstance signals such as the March 17/00 signal on the graph above which became a short consolidation period before there was a continuation of the price trend higher.  This type of signal cautions a trader to allow price trend to confirm the expectation before risking capital on the trade.  The April 18 signal is a special circumstance in that the trend leading into the critical day was still down despite a strong rise in prices on April 17.

Momentum trading is principally focused on early identification of trading opportunities that arise whenever markets move strongly in one direction or another.  Our critical day analysis identifies reversal points for the short trend.  When markets reverse direction there is often an opportunity to trade with change in trend in stocks, options, futures and sometimes mutual funds.  As a momentum trader there are a number of tools available to you to support and build evidence of trend reversals and changes in price momentum such as tell tale patterns on indicators and basic trendline studies.  An example below is a critical day combined with a trendline penetration where the trendline is the base of a triangle formation.  The critical day signal on Sept 21/00 is an expectation that markets will fall.  The penetration of the trendline, in blue, the next day on Sept 22/00 is supporting evidence that the price trend will continue in the direction of the penetration, in this case, down.