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What Is Momentum Trading?

Views 1092022.06.08

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Key takeaways

  • Momentum trading is based on the idea of "buying high and selling higher".

  • Momentum trading seeks to capitalize on the directional price trends of financial assets.

  • Momentum trading works better in a bull market, as investors tend to herd more.

Understanding momentum trading

Momentum trading is a strategy of buying and selling financial assets according to the recent strength of price trends. 

Momentum traders seek to capitalize on the directional trends in a stock price, either upward or downward. 

They open a position to take advantage of the expected price change and close the position when the trend starts losing its strength. For example, if a stock surges after reporting strong earnings, a momentum trader could acquire shares and ride the stock’s price upward.

In a word, momentum trading is all about trading with the trend.

Momentum trading is based on the idea that if there is enough force behind a price move, it will continue to move in the same direction.

When an asset reaches a higher price, it usually attracts more attention from investors, pushing the market price even higher. The price increase continues until a large number of sellers enter the market. Once enough sellers are in the market, the momentum changes direction and lowers an asset's price.

History of momentum trading

Researchers have identified persistent momentum trends in stock markets as far back as the Victorian Era (ca. the1830s to 1900).

Richard Driehaus, often considered by many as the father of momentum trading, he gained his prominence by popularizing the strategy. He took the practice and made it into a strategy to run his funds  Driehaus believes more money could be earned by "buying high and selling higher" than by buying underpriced stocks and waiting for the market to re-evaluate them. [i]

In the late 2000s, with the rapid development of computers and networking, computer-driven models made it possible for many more sub-variants of momentum trading to be deployed in the real markets. 

Disadvantages of momentum trading

When appropriately executed, momentum trading could turn a high profit over a short period of time. However, like any other trading style, some risks come with momentum trading.

Momentum trading is highly time-sensitive. Traders have to keep monitoring the market regularly as the price can fluctuate quite a few multiple times in a day. If the entry position is taken too late, the investment might turn out to be a loss.

Momentum trading is more suitable for a bull market where herding behaviors and price bubbles are quite common. However, in a volatile bear market, the investors should be cautious, which results in a shrinking margin for profit on momentum investing.

The content in this article is intended for general circulation and informational purposes only. It does not take into account the investment objectives, financial situation or needs of any particular person and should not be relied on as advice or recommendation. Information provided in this article are not specifically intended for or specially targeted at the public in any specific jurisdiction. Neither Moomoo Inc. nor its affiliates are licensed Financial Advisers and do not provide financial advice. You are advised to consult your financial adviser before making any commitment to invest in any capital markets product. The information published is not and does not constitute or form part of any offer, invitation or solicitation to subscribe or to enter into any transaction in capital markets products. Moomoo is a professional trading app offered by Moomoo Inc. In the U.S., investment products and services on Moomoo are offered by Futu Inc., Member FINRA/SIPC. In Singapore investment products and services are offered through Futu Singapore Pte. Ltd., regulated by the Monetary Authority of Singapore (MAS). This advertisement has not been reviewed by the MAS. Moomoo Inc., Futu Inc. and Futu Singapore Pte. Ltd are affiliated companies. Any illustrations, scenarios, or specific securities referenced herein are strictly for illustrative purposes. Past investment performance does not guarantee future results. Investing involves risk and the potential to lose principal.

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