Momentum Trading / Trend Trading

One of the more popular trading strategies is called momentum trading, or trend trading. This is because it is a relatively low risk strategy, not looking for and trying to anticipate sharp deviations in the price chart, but relying on the tendency for trends to continue for sometime. While some investors are of the opinion that the best way to profit from the stock market is to buy shares on price weakness (in the belief that the drop of valuation is only temporary), others prefer to profit from stocks with rising valuations. The logic behind this is that it makes sense to buy shares in a company that is doing well in the belief that earnings will continue to grow. For instance, by monitoring the performance of the shares within the FTSE 100 relative to the benchmark index you can identify which ones are leading or lagging the market and you would then go long the strongest and short-sell the weakest shares in the index. The idea with momentum trading is to identify a strongly trending security and trade with it until the trend weakens. Using CFDs you can easily multiply your money with a winning trade, because of the leverage that they provide.

 

The momentum trader therefore believes large increases (or decreases) in the price of an asset will be followed by additional gains (or losses). As it is as simple to take a short position as it is to take a long one with CFDs, you can look for a trend in either direction for your trade. For a long trade, you would start by looking for the strongest markets and sectors. Once you had narrowed it down to a range of securities, you could then pick the strongest in that range. The way you would identify the strongest in each case is by comparing the performance against an overall index. You would compare a sector's performance against the overall market, and then the individual security against the sector.

Another popular way to identify a security that is trending is to look for stocks making new 52 week highs. Sometimes novice traders take the view that they have 'missed that one' if it has been rising for a while, but this is to ignore the fact that it is still trending strongly, and therefore worth trading on. The idea here is to ride the next move higher on the back of the strong market momentum.

Price, momentum, Higher Highs and Higher Lows

Any price will continue in one direction so long as it has momentum in that direction. Buying momentum = HH (as buyers push the price higher) the price retraces as sellers step in and buyers take profits, yet both lose the battle to the new buyers, who buy from them, thus creating a HL, and then push the price up to a HH.

Would you step in front of a car accelerating towards you? The same with shares, If you apply this concept u will understand momentum. Momentum is lost when the price eventually fails to make a fresh high (LH) indicating that momentum may have ended. If the price makes a new low (LL) this may mean a reversal of the trend from up to down.

An UP trend is a series of HH's supported by HL's.
A DOWN trend is series of LL's with resistance being provided by LH's.

Another way to identify trends would be to utilise moving averages. The trading strategy here is to buy the instrument when the price closes above its moving average (uptrend signal) and to close the position when the price closes below it. Another system is to use two moving averages (say 5 and 20-day moving averages) and check the crossover of the two. The buy signal here will trigger when the shorter and faster moving average closes above the longer, slower one. But how to gauge when a trend is about to stall or reverse? One system is to use the last noteworthy low as the main level of support, and place the stop loss just below this level or look for double or triple top chart patterns. Alternatively, you can use technical indicators like the Relative Strength Index. When this moves over 70 it indicates that the market has been overbought and that the trend is likely to reverse, on the other hand readings under 30 imply that the market is oversold.

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If you are interested in placing a short trade you would look for the weakest sector, and then a weak security within that. Securities tend to lose value more quickly than they increase in value, so being able to trade short easily, as you can with contracts for difference, is an advantage and possibly generates profits more quickly.

As you are expecting to ride the trend for a few weeks, the entry point into your trade is not critical so it is not important to attempt to pinpoint precise entry levels, although this does not mean it should be ignored. However, entries are seldom as important as traders like to think. Money management is critical, and the first rule of trading is to have a stop loss level already picked out when you enter the trade. Opinion varies on whether this should be in an actual order placed on the market, and if your broker is a market maker you may want to think twice about this. It's usually enough to check the price each night, to see whether you will liquidate your position the following day.

The key with a momentum trade is not to get shaken out by the daily market volatility. If your trade goes into profit, you should set a stop level that prevents you losing it all again. Often, this will be a trailing stop which will follow the price up, but not go back down if the price falls. The only trick to this is to make sure there's room for regular fluctuations in price, without your trailing stop triggering and taking you out of the trade prematurely.

 ...Continues here - Dividend Stripping with CFDs

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