Momentum

Definition

Momentum is most commonly referred to as a rate and measures the acceleration of the price and/or volume of a security. It is also referred to as a technical analysis indicator and oscillator that is able to determine market trends. Traders and investors will often use the word “momentum” to mean one thing while the indicator itself represents a study in technical analysis. This explanation will primarily cover the indicator.

Takeaways

The momentum indicator is often paired with the trend line tool, to help traders and investors define a market trend. The tool is essentially a line that is drawn from the high price to the low price, from the low price to the high price, or from a specified time period. If the trend line is ascending, it means the trend is up and it’s considered a good time to buy stock. If the trend line is down, it signifies that the trend is down and it’s a good time to consider selling stock.

This is called momentum investing, a technical indicator on its own. Both momentum investing and momentum trading are more advanced in the fact that price trends are hard to predict and fluctuate rapidly, allowing for more risk.

What to look for

Momentum is not only a rate, indicator, and oscillator, but it can also be used as a trading technique. If it is clear that a stock’s price has accelerated or is accelerating, whether it be in overall earnings and/or revenue, a momentum trader can take either a long or short position in the stock while analyzing the stock’s momentum. The trade will hopefully continue its momentum in an upward or downward trend, rendering the trade successful. A strategy such as this one really focuses on stock price short-term movement.

Momentum trading is when a trader or investor buys or sells based on their analysis of the stock’s price movement and trends. To properly utilize a momentum-based strategy, traders will take a long position in a stock that shows an upward trend or a short position in a stock that shows a downward trend. Instead of the trading norm and buying low while selling high, momentum trading or investing flips that on its head. To trade within the strategy, it is best to sell low and buy even lower, or vice versa, buy high and sell even higher. It is also important to pay close attention to price breaks instead of focusing on reversal patterns in price.

Limitations

Like the majority of trading strategies, momentum trading and investing is not exempt from limitations and risk. Price trends and momentum analysis is never 100% reliable and shouldn’t be considered as such. In addition, momentum investing is done through investors and therefore, you are not in full control over your trades. It should also be mentioned that unexpected reversals are possible and remain unpredictable oftentimes. This is often due to changes within the market, breaking news, or overall trader market attitudes.

Summary

Momentum is a rate used to determine the acceleration of an asset or security’s price or volume. It can also be a technical analysis indicator and oscillator that works to determine market trends and whether a stock or asset’s price is going to continue its momentum upward/downward, or not.