Momentum Trading - Is it a good trading strategy?



The answer depends on what kind of risk return profile this strategy has and whether your temperament matches up to the temperament required in this strategy. So it's important to understand the contours of the Momentum trading style first to make a decision.

Technically momentum is mass times velocity and Physics says that if an object's velocity of movement is accompanied by large mass it will have very high tendency to continue to move in it's direction until and unless a massive force try to stop it or change it's direction. It has been witnessed that the same physics applies to stocks and markets as well. Whatever be the direction, if the movement of the stock is accompanied by larger volume it will have natural tendency to continue to move in that direction. 

Momentum traders try to capitalize this theory and always look for stock which are trending in one direction on high volumes and try to jump on board to ride the momentum train to a desired profit. This is 180 degree opposite to fundamental traders who are largely contrarian and looks for value in a falling stock. 

Momentum traders are usually day traders and rarely carry positions overnight. One of the most important character that a typical momentum trader has is that if a trade is on he will be glued to the screen and the moment saturation sets in and orders pile up on opposite direction he will quickly get out of the trade, even if it is making losses, and take position on the other side.

Momentum trading is most susceptible to human emotions which might restrict the trader in following the strict principles as desired in this style of trading. Momentum trading can be very rewarding as there is rarely any factor inside or outside the market that drives a stock as powerfully as momentum, provided the emotions are kept out of the trading room. Thus these days sophisticated algorithms are devised and used by large hedge funds and institutions to make their short term trades and capitalize on quick price movements. 



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