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Momentum Trading – Staying on the Move

Like most other trading techniques, momentum trading has its supporters and skeptics. Since this method of trading both disciples and detractors, it is important to define exactly what momentum trading is and what are its advantages and disadvantages in order to form an educated opinion.

In the simplest definition, momentum trading teaches that each year there are a few stocks that make five hundred to one thousand percent moves in the stock market. This fact can easily be seen by using one of the many free stock screeners that are available and entering the parameter that displays stocks that have gained at least 500% during the year. Depending on how the overall stock market has performed will dictate how many stocks show up in this search. Even during the severe bear market of 2000 and 2001 you will find dozens of small cap, unknown stocks that managed to make moves in excess of 500%.

Doing the math
Let’s take a minute and think about something. Imagine that every year there are 30 stocks that manage to make an 800% move in the stock market. Once you consider that, what would you have if you had jumped on these stocks after they had already moved 400% for the year? This is really the explanation of what momentum trading is. Momentum trading is getting on board a stock that has already been moving and putting in a strong performance for the year. You simply buy into it and with the expectation that it will continue its upward trend. Some stocks will continue to trend upward and some will not. With momentum trading you simply cut your losses quickly and ride the winners for as long as they keep heading in the right direction.

Many people will look at a stock which has already gained 400% and say it has probably already peaked. Instead of momentum trading, they would rather get in at the bottom and ride the stock from that point to a four hundred percent profit point. Who wouldn’t want that? Most people have been taught by the “stock gurus” to always buy low and sell high; this is great advice but it can be short-sighted. You have no way of knowing which stocks the market will fall in love with and which ones it won’t. At best fundamental trading technique can end up being little more that a random coin flip. You can pick two equally great-looking stocks, both with fantastic earnings and prospects, and one will languish while the other will go on to make earn an amazing profit. Is that really a risk that you are willing to take? With momentum trading you don’t have to take this risk because you move out of positions when the change directions.

Trying to pick a stock at its very bottom point is a greedy trap. Some people just are not happy with doubling or tripling their money; they want it all. Greed and fear are the emotions that always have, and always will destroy your stock market profits; momentum trading can help you avoid such traps.

Momentum trading has another advantage that is often overlooked. The benefit is the speed at which profits are made. Making a 500% return on a stock is great but if it took six years to make it then you have grown somewhat slowly. Trends start slowly and gather momentum as they continue so you know the fastest movement in a trend is in the most recent quarter. That’s why this practice is called momentum trading because the longer it goes, the better it does.

Momentum trading can provide another stable method for realizing consistent gains. By choosing stocks that have been on a strong upward trend, it is possible to enjoy a considerable (and profitable) part of that trend. If the direction does change, you can simply get out and move into something else. Momentum trading can keep you on the move as you build up trading profits.

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