In our series of covering various forex trading strategies we have momentum trading strategies. If you have been following our articles you have found out by this point that trying to use the same strategy for any situation in the market is trying to push a square peg in a round hole. It just won’t work.
So if you want to have the highest degree of success as a trader, you need to fill your arsenal with the varied techniques, tools, and trading strategies. In this article, as mentioned at the beginning, we are going to focus on momentum trading.
In this article we are going to focus on the definition of momentum trading in forex, how momentum trading works, how to use momentum trading in forex, and what techniques are involved in this strategy.
What Is the Definition of Momentum Trading?
While some strategies might be complex and made of detailed parts, momentum trading is known for its simple and straightforward manner. In essence, this form of trading helps traders to open positions based on the current trend or momentum in the market.
Now, the degree to which these positions or trades will be successful will ultimately depend upon the strength and power of the trend in question.
Momentum trading has become more and more prevalent as traders have come to realize the power of trends that form in the market. These trends in the market could form for many different reasons. In recent years, we have even come to realize that user sentiment can form trends with powerful momentum in the market.
No matter the reason, if you notice the market momentum at the right time and start riding the momentum, you can make substantial profits.
How Does Momentum Trading Work?
There are two sides to every strategy. One side has to do with the trader. Of course it is up to the trader to do the calculations in the correct way and to make sure that they have done their due diligence.
The other side of every trading strategy, however, is concerned with the market itself. Movements that take place in the market are naturally out of any trader’s control.
With respect to momentum trading, the way it works, and in fact the only way that it will work, is that the momentum or the prevalent trend in the market holds up under all the pressure.
If the momentum is not strong, of course it will break in a direction that could result in substantial losses. However, no trader can be sure that the momentum in the market will last. So there is always a percentage of risk associated with this trading strategy.
How to Find a Powerful Momentum for Trading?
Remember in all strategies of trading, if the calculations are not carried out properly, then the result could be very detrimental for your assets. The same is true with momentum trading.
If you do not find the right momentum or if the momentum you have chosen fails to hold up under real market conditions, then your orders will result in loss.
The way most traders who use momentum trading make sure of the strength of the momentum is that they wait until the trend has fully formed. And then they jump onto it.
When you consider a long term trend or momentum in the market, the best way that most traders choose to begin trading is when the momentum has reached its midway point.
What Indicators Are Associated with Momentum Trading?
As with most of the other trading strategies, fundamental analysis does not have much use in momentum trading. The main type of analysis that is done is technical analysis. So in this section let’s take a look at the types of technical indicators that are used in momentum trading.
- Relative strength index: otherwise known as RSI, this is the most common technical indicator used for identification and analysis of momentum in the market. RSI oscillates between the two values of 0 and 100 and it is mainly used to identify whether an asset has been overbought or oversold. And in this way the relative strength index can show the momentum in the market.
- Moving average convergence divergence: also known as MACD, this indicator is used in various strategies as the main or subsidiary indicator. However, it is also mainly used in momentum analysis. This type of moving average is not made from only one average line. In fact, the moving average convergence and divergence is made from three different average lines. The average line in the middle can show the strength of the momentum or trend in the market. But keep in mind that MACD, similar to many other indicators, is a lagging indicator. This means that it waits for the data to first form in the market and then analyze them for presentation to the user. Keep that fact in mind if you want to count on such indicators for the long term.
- Stochastic oscillator: once you have used technical indicators such as the one mentioned above to find out where the momentums exist and what the best entry point is, you can use indicators such as stochastic oscillators for the continuation of your position. The reason is that the stochastic indicator is a leading indicator. This means that this classification of indicators is used to predict the patterns that will form in the market, not the patterns that have already formed. Similar to other indicators, the stochastic oscillator also moves back and forth between the two values of 0 and 100 and is mainly used to identify areas of overbought and oversold states in the market.
These are only a few indicators that can be used in momentum trading. There are many other indicators that can help you identify trends in the market and keep tracking them for your positions.
How Can You Use Momentum Trading in Forex?
The reason we have focused our attention on the forex market throughout this article is not just because we love the forex market. Of course we do! But that is beside the point.
The actual reason has to do with the nature of momentum trading. Momentums rely heavily on volatilities and high liquidity or trading volume to form. And these elements are always found in the forex market. That is why momentum trading is one of the suitable strategies that can be implemented by traders in this market.
Though, keep in mind that there is not a single person on earth who can claim they know what is going to happen in the market. That future of the market is unknown to all. So if you want to use momentum trading, do so with caution.
Make sure to go through all the steps carefully when you want to identify the existing momentum in the market. And certainly use leading indicators to analyze and predict what is about to happen.
Momentum trading is one of the most popular strategies of trading in any market, especially in the forex market. According to this strategy, traders will enter into positions based on the strength of price trends or momentum of them. The idea behind momentum trading is to identify these trends and enter at the right time, hold your position while the trend lasts, and exit before the momentum decides to change trajectory and turn the other way.