10 Things Momentum Traders Need to Focus On

10 Things Momentum Traders Need to Focus On

At Investors Underground know, our main chat room is focused primarily on momentum trading. We have 2 other chat rooms for swing trading and OTC trading, but the main room is focused solely on momentum. Understanding what momentum trading is will give you a better idea of our approach to day trading.

Momentum traders take advantage of short-term price action in a stock. Whereas a swing trader may hold a stock for days or weeks, a momentum day trader will generally buy and sell a stock within the same day.

Finding ideal trading candidates is of paramount importance. Not all stocks provide momentum trading set ups, and focusing on the wrong stocks will waste your time and cost you money. Here are a few things to look for

Stock Volume

A stock's volume is simply the number of shares that are traded. As mentioned above, the goal of momentum trading is to get in and out of a position in the same day. In order to do this, you need to make sure that there are enough buyers and sellers. Therefore, it's important to focus primarily on stocks that have high volume. This allows us to get in and out of trades with ease. High volume stocks have higher liquidity, meaning it can be bought and sold quickly.

Momentum Trading Volume

Volatility and Range

As a momentum trader, there is nothing exciting about a non-volatile, range-bound stock. We are looking to take advantage of intraday price action (keyword: "action.") We're not trying to scalp stocks for a few cents; we want to play significant moves in the market. If a stock is stuck in a $0.30 range for the day, there are very little trading opportunities. Contrarily, if the stock is trading in a $5 range, there may be profitable trade setups.

Comparing a Stock's Range

Time Frame

Momentum trading is focused on short term moves in the stock market. We don't care what a stock is going to do a month from now. We're focused solely on what is going to happen during the day. This is part of the rationale for why we don't care about the condition of the underlying company. A terrible company can experience exponential price increases, and a great company can be undervalued for ages.

Of course, it's still important to pay attention to the longer timeframe charts so you can understand significant price levels, but you're trade plan should be focused on short term price action.

Day Trading and Swing Trading

Technical Analysis

Whereas investors care a lot about the underlying company, momentum traders only care about the stock itself. You'll hear me say time and time again, "Trade the ticker, not the company." As momentum traders, all we care about is price action. We save the balance sheets and income statements for the investors. In the world of momentum trading, the stock IS the product.

Every chart tells a story. A stock chart tells us how much money people are willing to pay for a stock at a given period. Reading and understanding these charts is known as "Technical Analysis." We analyze chart patterns to make predictions about the market. If you find yourself justifying a position because of a characteristic of the underlying company, you are in the trade for the wrong reason.

Trade the Stock Ticker

Catalysts

As mentioned above, momentum traders are focused on trading volatile stocks in a short time-frame. We are interested in new catalysts that can cause a stock to break out or break down. Keep in mind, we do not care about the actual implications of the catalyst, but the reaction of the market. For example, when there was an Ebola scare in America, the stock prices of many companies in loosely related sectors skyrocketed. Was this price movement rational? No, but it created many trading opportunities. Understanding the catalyst of a move can help you gauge the magnitude.

High Risk/Reward

Many people compare day trading to gambling, and, if done improperly, the two can be similar. What separates a day trader from a gambler is research and risk/reward analysis. This is similar to any business.

It's estimated that 80% of entrepreneurial ventures fail within 18 months. Does this mean starting a business is gambling? Yes and no. There is an inherent risk to most things we do. That said, there are ways to mitigate this risk. In day trading, we do this by finding stocks with favorable risk/reward ratios. For example, if you enter a stock blindly, you basically have a 50/50 chance of making a profit; this is gambling. If you analyze patterns, study technical analysis, and find favorable risk/reward setups, you can lower your risk. In general, you should never risk more than $1 for every $3 you expect to make.

Risk Reward Ratios for Momentum Trading

Sector Strength

Certain sectors start running at different times. For example, marijuana stocks ran when new laws were passed and non-lethal weapon stocks ran when police brutality was in the headlines. Understanding sector trends can help you better understand why certain stocks are moving. It can also help you find more stocks to trade within the sector.

Marijuana Sector Run

Market Strength

Paying attention to the strength/weakness of the broader markets can help you understand "momentum" at a larger scale. This can be done by looking at the indices such as the S&P, DOW, and NASDAQ. The broader market strength speaks to the overall sentiment of the market. For example, if the S&P is up 3% on the day, the market would be considered bullish, therefore, the probability of bullish setups working out in your favor is increased.

Stock Trends

This should go without say, but it's important to focus on the trend of a specific stock. You never want to fight the trend. So, if a stock has been uptrending all day and you decide to short it, you are fighting the trend and increasing your risk.

Trend Lines

Trading Setups

This is another one that should go without say, but some traders neglect to focus on it. If you are entering a position in a stock, there should be a reason. You should be able to answer the question, "Why did you enter the stock at that price?"

Your answer should be well-thought out and rationale. "I think it will go up in price later" is not a good answer, whereas "The stock was breaking out of an ABCD pattern and the risk/reward ratio was 1:4" provides solid rationale.

Trading Setups