MOMENTUM TRADING: AN INSIGHT

In momentum trading, traders focus on stocks that are moving significantly in one direction on high volume. Momentum traders may hold their positions for a few minutes, a couple of hours or even the entire length of the trading day, depending on how quickly the stock moves and when it changes direction.Styles of equity trading:

• Scalping
  The scalper is an individual who makes dozens or hundreds of trades per day, trying to "scalp" a small profit from each trade by exploiting the bid-ask spread.
• Momentum Trading
  Momentum traders look for stocks moving significantly in one direction on high volume and try to jump on board to ride the momentum train to a desired profit.
• Technical Trading - Technical traders are obsessed with charts and graphs, watching lines on stock or index graphs for signs of convergence or divergence that might indicate buy or sell signals.
• Fundamental Trading
  Fundamentalists trade companies based on fundamental analysis, which examines corporate events such as actual or anticipated earnings reports, stock splits, reorganizations or acquisitions.
• Swing Trading
  Swing traders are really fundamental traders who hold their positions longer than a single day. Most fundamentalists are actually swing traders, since changes in corporate fundamentals generally require several days or even weeks to produce a price movement sufficient enough for the trader to claim a reasonable profit..
  
  A Day in the Life of the Momentum Trader
  
  He gets up an hour before the market opens and immediately logs into one of the popular trading chat rooms or message boards.
  When looking at these boards, our hero focuses on stocks that are generating a significant amount of buzz. He looks at stocks that are the focus of trading alerts based on earnings or analyst recommendations. These are stocks rumored to be in play, and they are anticipated to provide the most significant price movements on high volume for that trading day.While surfing the web, he will also turn on CNBC and listen for mentions of companies releasing news or positioned to undergo significant movement.He eyes the morning equity options pages to find stocks with significant volume increases in calls. Any increase in calls written indicates that a price increase or decrease above or below the option premium is expected.He will then narrow his watch list to include only the strongest stocks: those increasing more rapidly on higher volume than the rest of the market, stocks trading contrary to the market and stocks with movements clearly propelled by external factors.
   Next, a momentum trader will analyze the list of stocks he has chosen to focus on by examining their charts. The primary technical indicator of interest is the momentum indicator - the accumulated net change of a stock's closing/ending price over a series of defined time periods. The momentum line is plotted as a tandem line to the price chart, and it displays a zero axis, with positive values indicating a sustained upward movement and negative values indicating a potentially sustained downward movement.
  
  That upward or downward momentum indicator often immediately portrays a breakout for the stock, which means that even a period or two of sustained momentum will propel that stock in the direction of the breakout. When the trader believes he has identified a breakout, he does not necessarily need to jump immediately into the stock. He is not generally worried about missing the first one or two breakout ticks, but he has his hand on the buy trigger for one of the next momentum periods. And he is generally not too concerned about hitting the bid either, as he will have an easier time getting in at the market price. Then he places a market order. Once he has entered into his position, the white-knuckle ride and nail-biting begins. Whether the momentum fizzles almost immediately or continues to build, the trader remains glued to his screen. He is looking for a saturation point, where orders start piling up on the offer and bidding slows or thins at the market price a few levels back on the Level 2 screen. The saturation point does not mean an immediate end to the momentum, but it may signal that the top is near. So the trader sells his position (or covers his position in the case of a short sale) and takes his profits to pack it in for the day or to move on to the next stock on his list.
  
  Note that in the event of a breakout gone wrong, where a stock immediately turns direction and moves against the trader's wishes, a special strategy applies. Far from hoping for yet another reversal to make the stock go his way, this astute trader immediately cuts his losses and sells (or covers) his position. It is often a far better strategy to take a small loss early after a bad trade than to hope for a reversal later in the day. The odds generally ensure that a small loss will turn much larger the longer the trader waits with crossed fingers.
  
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The Bottom Line
Because of these pitfalls, momentum trading is fraught with peril that can easily destroy even the most disciplined and knowledgeable trader. However, this style also offers the most potential for significant profit, since rarely any factor inside or outside the market drives a stock as powerfully as momentum. With a proper understanding of the technique, sufficient knowledge of the risks and a willingness to take an occasional loss, momentum trading offers an appealing choice for the aspiring trader who enjoys living on the edge.