Momentum Trading & Its Advantages Explained

Momentum trading uses the market’s momentum to one’s advantage. Traders thus buy securities when prices are increasing, and sell the securities when the prices have peaked. Traders are thus able to yield maximum gain from an open position or measure the probability of a potential trade.

By predicting the near-term future movement of the security, traders can chase the market and make consistent profits. Market momentum in this sense thus refers to the market and price of the security distinctly favoring movement either upwards or downwards.

Momentum traders are thus high-risk and short-term trading strategies where traders work with the volatility to buy securities in short-term uptrends and sell when the price of the securities dip and lose momentum. Here are some of the advantages of momentum trading and how they help to improve your profits.

High Profitability in A Short Period of Time

Momentum trading can result in lucrative profits if executed correctly and consistently. Some traders and investors may buy and hold stocks for years and decades to reap profits. However, successful momentum traders can leverage the momentum of the market to consistently generate profits on a daily or weekly basis.

An example would be if you buy a stock or security which grows from $30 to $45 due to the positive reports about the company and its stock. You are thus able to sell the stock at $45 before the market correction occurs and make a 50% profit. Momentum investing thus allows for a much larger profit potential due to its reliability and the fact that you are riding on the wave of the market and its direction.

Ease of Trading Management

Momentum trading provides for a less stressful trading environment and makes it easier for you to manage your trades. By expecting a sharp move in a certain direction, the trader can resort to intuitive and comfortable trade management. Traders are thus focused on the technical analysis of the charts and the market direction of the security in momentum trading.

Compare this to long-term investing which is much more complex such as considering various fundamental factors such as the stock’s valuation, company performance, and many more. Momentum trading provides ease of trading management as you only have to focus and analyze in which direction the market will move.

Leveraging The Market’s Volatility to Your Advantage

Momentum traders can easily recognize and avoid difficult range-bound trading conditions. They are also able to quickly exit market trades that are not going well. This is because they can leverage the volatility of the market to their advantage by identifying signs of changes or drops in the market rhythm.

This allows them to timely exit the market before potential losses. For example, a momentum trader purchases a stock at $60. The stock’s price has been increasing consistently and the trader decides to sell the stock at $80. While the price of the stock starts to dip when reaching a maximum of $100, the trader can sell the stock and make a profit long before prices decrease. This thus maximizes return on investment (ROI).