Momentum trading is based on a simple principle: stocks in motion tend to stay in motion. When a stock starts moving strongly in one direction, momentum traders jump on board and ride the wave until it shows signs of slowing down.
What is Momentum Trading?
Momentum trading involves buying stocks that are rising and selling stocks that are falling. Instead of trying to predict reversals or find undervalued stocks, momentum traders follow the current trend and profit from its continuation.
The philosophy is straightforward: "The trend is your friend." Momentum traders do not fight the market - they go with the flow.
Core principle: Stocks that have been rising tend to continue rising. Stocks that have been falling tend to continue falling. This is momentum, and it exists because of investor psychology and institutional buying patterns.
Why Momentum Trading Works
Momentum exists in markets for several reasons:
- Institutional buying: Large funds cannot buy all at once - they buy over days or weeks, creating sustained momentum
- Investor psychology: Fear of missing out (FOMO) drives more buyers to rising stocks
- News cycles: Positive news leads to more positive coverage, attracting more buyers
- Algorithmic trading: Many algorithms are programmed to follow momentum
- Self-fulfilling prophecy: As traders pile in, their buying creates more momentum
How to Find Momentum Stocks
Pre-Market Scanning
Start each day by identifying stocks with momentum:
- Gappers: Stocks gapping up or down on news
- Volume spikes: Unusual pre-market volume
- News catalysts: Earnings, upgrades, contracts, FDA approvals
- Sector strength: Stocks in hot sectors
Technical Indicators for Momentum
- Relative Strength (RS): Compares stock performance to the market
- Rate of Change (ROC): Measures price change over a period
- RSI above 70: Shows strong bullish momentum
- MACD crossovers: Signal momentum shifts
- Moving average trends: Price above 9 and 20 EMA indicates momentum
Volume Confirmation
True momentum requires volume. Look for:
- Volume at least 50% above average
- Increasing volume as price moves
- Volume spikes on breakouts
Momentum Entry Strategies
1. Breakout Entry
Enter when price breaks above a significant resistance level:
- Wait for the break to occur with volume
- Enter on the breakout or on the first pullback
- Stop loss below the breakout level
- Trail your stop as the stock moves higher
2. Pullback Entry
Wait for a momentary dip in a strong uptrend:
- Identify stocks in clear uptrends
- Wait for price to pull back to support (like the 9 EMA)
- Enter when the pullback shows signs of ending
- Stop loss below the pullback low
Pro tip: The best pullback entries happen when the stock bounces off a moving average with increasing volume. This shows buyers stepping in at support.
3. Opening Range Breakout
Trade the breakout from the first 15-30 minutes of trading:
- Mark the high and low of the first 15-30 minutes
- Enter long when price breaks above the range high
- Enter short when price breaks below the range low
- Works best on momentum stocks with catalysts
Momentum Exit Strategies
Knowing when to exit is as important as knowing when to enter:
Signs Momentum is Fading
- Volume decrease: Rising price on falling volume
- Candle patterns: Doji, shooting star, or reversal candles
- RSI divergence: Price makes new high but RSI does not
- Moving average break: Price drops below 9 EMA
- Failed breakout: Price breaks out then reverses
Exit Methods
- Trailing stop: Move stop up as price rises
- Moving average stop: Exit when price closes below 9 EMA
- Time stop: Exit if trade does not work within expected time
- Target exit: Take profit at predetermined resistance levels
Momentum Trading Rules
- Trade with the trend: Only buy stocks going up, short stocks going down
- Enter early: The best profits come from catching momentum early
- Volume confirms: Never trust a move without volume
- Cut losses fast: Momentum trades that do not work fail quickly
- Let winners run: Use trailing stops to maximize gains
- Be selective: Wait for the best setups
Momentum Trading vs Other Strategies
Momentum Trading
- Follow the trend
- Buy strength, sell weakness
- Quick entries and exits
- Higher win rate potential
- Works best in trending markets
Value/Reversal Trading
- Fight the trend
- Buy weakness, sell strength
- Longer holding periods
- Lower win rate, larger wins
- Works in ranging markets
Common Momentum Trading Mistakes
- Chasing: Entering too late after a big move
- Ignoring volume: Trading momentum without volume confirmation
- Fighting the trend: Shorting strong stocks or buying weak ones
- Over-holding: Holding too long as momentum fades
- No stop loss: Letting losers run
- Averaging down: Adding to losing positions
Best Markets for Momentum Trading
Momentum trading works best when:
- Markets are trending (not ranging)
- Volatility is moderate to high
- There are clear sector leaders
- News events are creating catalysts
Momentum trading struggles during choppy, directionless markets. During these times, reduce position size or switch to range-trading strategies.
Track Your Momentum Trades
Pro Trader Dashboard tracks all your trades and shows which momentum setups work best for you. See your win rate by entry type and optimize your strategy.
Summary
Momentum trading is about following strength and avoiding weakness. Find stocks with strong momentum, enter on breakouts or pullbacks, and ride the trend until momentum fades. Success requires discipline, quick decision-making, and strict risk management. Start by mastering one momentum strategy before adding complexity.
Ready to learn more? Check out gap trading strategies or discover proven day trading setups.