Momentum trading is an investment strategy, which involves purchasing financial assets like stocks, indexes, derivatives, bonds, or commodities that are displaying upward price movements with the expectation that these trends will keep rising, at least in the short term.
Momentum trading is based on the premise that strong financial assets will continue to experience a rise in price while weak ones will continue to decline.
In momentum trading, traders will buy a financial asset when its price has begun to rise and sell it the moment the price begins to fall. The basic goal is to make gains from the market’s ongoing movements. Generally, there are two ways in which momentum trading is undertaken:
Short-term momentum trading: This method involves searching for short-term price trends. It could range from a couple of minutes to hours, or days. Short-term momentum traders are referred to as day traders. As per the market scenario, chart time frames can be chosen to identify the trend.
Long-term momentum trading: In this, traders utilise daily, weekly, and monthly charts to identify long-term uptrends or downtrends for the market and any specific security. By using more extended time frames, it reduces much of the volatility witnessed in shorter time frames. The focus is to capture sustained price movement over a longer time period, which could range from weeks to months.
While short-term momentum trading involves active monitoring and immediate decision-making, long-term trading calls for a patient approach and involves a comprehensive understanding of the market trends.
Momentum investing can no doubt provide high returns but is also prone to high risk. One of the most significant risks associated with momentum is related to high volatility. An investor must first analyse their risk-bearing appetite and then take the plunge accordingly to adopt momentum trading, which is known to provide a positive opportunity.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.
