Price momentum is one of the most reliable phenomena in financial markets. Stocks that have been going up tend to continue going up, and stocks that have been going down tend to continue falling. Understanding how to trade momentum can significantly improve your trading results.
What is Price Momentum?
Price momentum measures the rate at which a stock's price is changing. Strong upward momentum means prices are rising quickly, while strong downward momentum means prices are falling rapidly.
The momentum effect: Academic research has shown that stocks with strong recent performance tend to outperform over the next 3-12 months. This persistence of returns is the foundation of momentum trading.
Measuring Price Momentum
Rate of Change (ROC)
The simplest momentum measure:
- Formula: ((Current Price - Price N periods ago) / Price N periods ago) x 100
- Interpretation: Positive ROC = upward momentum, Negative ROC = downward momentum
- Common periods: 10-day, 20-day, 50-day
Momentum Indicator
- Simply the current price minus the price N periods ago
- Oscillates above and below zero
- Above zero = bullish momentum
- Below zero = bearish momentum
Price Percentage Change
- 1-month return for short-term momentum
- 3-month return for intermediate momentum
- 6-12 month return for long-term momentum
Momentum Trading Strategies
1. Trend Following
The classic momentum approach:
- Buy stocks making new highs
- Hold while the trend continues
- Exit when momentum fades or reverses
- Use trailing stops to protect gains
Trend Following Example
A stock breaks out above its 52-week high on strong volume.
You enter a long position with a stop below the breakout level.
As the stock rises, you trail your stop using the 20-day moving average.
You exit when the stock closes below the 20-day MA.
2. Momentum Breakouts
Trade breakouts from consolidation patterns:
- Identify stocks consolidating after an advance
- Enter when price breaks above the consolidation
- Look for increasing momentum on the breakout
- Set stops below the consolidation low
3. Pullback Trading
Buy strong stocks during temporary weakness:
- Identify stocks in established uptrends
- Wait for a pullback to support (moving average, trendline)
- Enter when momentum indicators turn positive
- Ride the next leg up in the trend
Warning: Momentum Can Reverse Quickly
Momentum stocks can experience sharp reversals when the trend ends. Always use stop losses and never let a winning trade turn into a big loser. The same momentum that pushed the stock up can push it down just as fast.
Momentum Confirmation Signals
Strong Momentum Signs
- Price above key moving averages (20, 50, 200-day)
- Moving averages in bullish alignment (shorter above longer)
- Higher highs and higher lows
- Increasing volume on up days
- RSI staying in bullish zone (40-80)
Weakening Momentum Signs
- Smaller price gains despite effort
- Bearish divergences on indicators
- Decreasing volume on rallies
- Breaking below short-term moving averages
- Lower highs forming
Momentum Across Timeframes
Momentum works across different timeframes:
- Day traders: 5-minute, 15-minute momentum
- Swing traders: Daily and weekly momentum
- Position traders: Weekly and monthly momentum
- Best approach: Align multiple timeframes for confirmation
Common Momentum Mistakes
- Chasing extended moves: Entering after a stock has already run too far
- Ignoring stops: Holding losers hoping momentum will return
- Fighting the trend: Shorting strong stocks or buying weak ones
- Overtrading: Trading every wiggle instead of the main trend
- No profit taking: Letting winners turn into losers
Risk Management for Momentum Trading
- Position sizing: Smaller positions in volatile momentum stocks
- Stop losses: Always define your exit before entering
- Trailing stops: Lock in profits as the trend extends
- Diversification: Spread risk across multiple positions
- Time stops: Exit if the trade does not work within expected timeframe
Track Your Momentum Trades
Pro Trader Dashboard helps you analyze which momentum setups work best for your trading style.
Summary
Price momentum trading capitalizes on the tendency for winning stocks to keep winning. By measuring the rate of price change and following established trends, momentum traders can ride strong moves while managing risk with disciplined stop losses. The key is entering with the trend, letting winners run, and cutting losers quickly.
Learn more: Relative Strength Analysis and Volume Momentum Analysis.