The Momentum Trade
|Pattern Cycles generate powerful strategies to
capitalize on changing conditions and major turning
points. But most traders fall into the momentum game and
never learn other tactics. While the greedy eye sees
rising trends with few pullbacks, most still lose money
chasing a hot market. They realize too late that
momentum demands precise timing and strict emotional
||Greed-fear exerts tremendous force during dynamic price
movement and clouds careful preparation. Ironically
initial gains can be dramatic for new momentum traders.
Beginners luck and fearlessness combine to make those
first weeks or months very rewarding. But results often
change quickly. Momentum traders at all levels lack
sound risk management.
|Focus on the big gain dulls awareness of the big loss.
Market insiders adjust quickly to the momentum crowd and
generate sharp whipsaws to shakeout the weak hands.
Confused participants start buying tops and selling
bottoms with regularity. Or they abandon their rules and
try to survive by holding old winners through violent
selloffs and waiting for a bounce.
The untrained eye sees continuous price change
but trends last only a short time compared to
constricted ranges. During one phase of Rambus'
February move, the stock printed 15 trend bars
compared to 53 sideways range bars. Without
excellent timing, momentum traders have many
opportunities to fail.
Sharp trends print wide range bars and many gapping
moves. This volatility increases risk and inhibits safe
entry-exit planning. Swing traders rely on
support-resistance to define execution and reward
targeting. Momentum markets often display no common
landscape features at all. This requires entry without a
clear violation level that proves that the setup was
wrong. In this blind environment, arbitrary stop losses
may be the only way to keep the speculator out of
Momentum trading can be mastered. Three disciplines will
break destructive habits and reprogram trading for
- Abandon the adrenaline rush: Forget the excitement.
Profit depends upon detached and disciplined execution.
- Learn the numbers: The nature of price movement must
be ingrained deeply enough to allow spontaneous
decision-making during the trading day.
- Cross-verify: Objective measurements must filter
Reduce momentum risk through 3-D charting. Identify
reward for the time frame of interest. Confirm that the
stock shows no important divergences that may signal the
end of the move or an impending reversal. Then guide
execution and position management through the chart in
the next lower dimension. When a strong trend explodes
on the daily view, use a 60-min bar to pick out low risk
entry and define natural exit points. For intraday
positions, control the 5-min bar breakout by using a
1-min chart to locate the natural swings.
Successful momentum strategy requires solid tape reading
skills. Demand on the time and sales ticker reveals the
inner workings of rapid price movement. Both retail
(small lot) and professional (large lot) traders need to
participate in a sharp trend or it will fail. Watch the
crowd's response to support numbers very closely. If you
can't feel their urgency to get on board, perhaps it
isn't there. When the action pushes into uncharted
territory, use round numbers to gauge demand. Multiples
of 10 present strong resistance in place of classic
support levels. Understand the motives of the big
players that drive fast markets and ride their coattails
to gain a needed edge. And if you see big lots move
against a rally, be prepared to join them.
Time of day tendencies create profit and danger zones.
As the market opens, overnight imbalance and fresh
retail cash trigger volatility that resolves through
price change. Insiders guide stop gunning exercises and
fade trends through the lunch hour's negative feedback.
The final hour arrives, just in time to resolve many
complex themes with sharp breakouts or breakdowns. And
through it all, intraday buying and selling oscillates
in an orderly 90-min cycle.
Swings: Intraday volatility shakes out day
traders during a 3-hour, 16-point NXTL rally.
Short-term price movement responds to numerous
intermarket cycles that ensure a bumpy rise for
the momentum crowd.
Technical analysis uncovers momentum secrets as it
exposes insider deception and herd emotions. Verify all
shock events through both patterns and indicators.
Proper application will reduce entries associated with
false breakouts and invoke natural risk management.
Always trade by the numbers and not the news. Use their
cold logic to painlessly exit momentum positions and
move on quickly to the next opportunity.
Physics teaches that an object in motion tends to remain
in motion. Profits depend on this well-understood
mechanism. Moving averages set to multiple time frames
reveal trend velocity through their relationships with
each other. Measure this acceleration-deceleration with
a classic MACD indicator or apply MA Ribbons to see if
they spread or contract over different time periods. For
obvious reasons, always seek acceleration
cross-verification before momentum trade execution.
Swing traders apply original tactics to each phase of
the Pattern Cycle. At new highs, they execute momentum
setups that rely on sound risk management. When market
conditions change, they move swiftly onto fresh ideas
that reflect the new inefficiencies. Always
opportunistic, they seek the next profit like the
predator looks for vulnerable prey.
Momentum strategies fail through most market conditions.
Stocks trend only 15% to 20% of the time. Constricted
ranges bind price during the rest of its existence.
Trading longevity requires diverse skills through both
trending and congested markets. Be flexible enough to
shift from one strategy to the other as feedback loops
alternate between positive and negative. In other words,
adapt tactics quickly to changing market conditions
rather than wait for those limited times when the
environment favors the hot stock.