Momentum trading is one of the most popular methods of trading that is short-term. It is the process of identifying a change in the price of an asset and trading towards the direction that the price changes with the hope of the asset’s price continuing to increase in that direction.
In the field of Physics, Momentum refers to describing the mass of an object and its directions of movement. In the financial market, the term “momentum” of an asset refers to the direction and the speed of fluctuation of the asset on the market.
Momentum trading is a strategy that allows you to analyze assets over the short term, and then purchase those assets whose value is increasing. Then, you sell the assets when it appears that the price has been pushed to the limit, thus making an income. The idea behind this is that if there are enough forces behind a price change the price will continue to rise in the same direction.
Momentum trading is a bit more complex than long-term value investing strategies. It requires a number of tools and technical indicators to be used in accordance with the specific strategy.
Even though there are numerous providers of these technical tools, we will focus on the ones offered by Elite CurrenSea, a European-based fintech company focusing on algorithmic trading. Apart from the advanced ECS momentum indicator, the provider also supports various tools and other indicators. We will cover them in greater detail later in the article.
Momentum trading is different from the standard strategy which consists of “buying cheap and then selling at a high price”. In the past, the strategies for momentum trading have proven to be lucrative in financial markets. In the real world, it is believed to be more well-known in comparison to “buying lower and trading high”. This is due to the fact that you purchase something that’s going up.
You don’t have to purchase an asset that is undervalued and then wait for the market’s reassessment of this particular stock until the investment eventually becomes profitable.
Another benefit of using momentum trading is that it is the potential for huge returns over a brief period. Because you’re leveraging fluctuations in the markets to benefit you, movement trading is ultimately boiled down to following the market’s performance to increase the value of your investment.
The strategies for trading on momentum identify opportunities in the short-term changes in the price of an asset. It is believed that if the value of an asset increases the price will continue to rise in the absence of other influences. Think of momentum trading like an automobile moving. Its speed slows when you begin to move ahead. This is the time to spot an item that is rising in value. When the car speeds up it speeds up.
If you’ve found the inventory and bought it, the value of your investment begins to increase. When you see the red signal on the road when a red signal is displayed, the car slows down, and speeds decrease. It’s similar to when you take out your investment at a profit after observing a decline in momentum in the price of the asset.
The recognition of a trading opportunity that is based on momentum is crucial to ensure that you are able to time the entry point into an asset. To identify momentum it is possible to utilize technical indicators or statistical analysis.
The most common technical indicators presented to Elite CurrenSea clients are as follow:
- Momentum Indicator: An oscillating indicator that is used to verify the direction of a price of an asset.
- RSI Indicator: A fluctuating indicator that can tell if an asset is either overbought or oversold.
- Moving Averages can be used as indicators to detect emerging trends in the value of the asset.
- Breakout indicator: They may be used to determine the price breakout or volume.
- Analytical Statistical: could apply statistical analysis similar to using the Hurst Exponent test. This test relates to the autocorrelation of the asset. It is a method to determine whether an asset’s trend is present or not.
There are two kinds of trading in momentum. Cross-sectional and time-series momentum. Time-series-related momentum is the result of the amount of performance an asset has in relation to its historical performance. The time-series momentum can be identified using the percentage of profit that is a threshold which is then the assets that are above the threshold are acquired.
Cross-sectional momentum measures the performance of an investment compared with other investments in the portfolio. It could be the best performing assets to be purchased, and the worst 10 assets that are performing that are being transferred.