Momentum trading leverages market volatility to the trader’s advantage by identifying the strength of the market’s current trend. It also provides traders with future market momentum predictions. In our article, we will learn in-depth about momentum trading and the top momentum trading strategies.
What is momentum trading?
Momentum trading refers to buying and selling currency pairs in the forex market as per their existing price trend’s strength. This means if a currency pair is moving in a strong upward or downward direction, it is going to continue to move in the same direction in the near future, enabling traders to place orders along with the market trend. However, if the current price trend of a currency pair is weak, it is advised to place orders in the opposite direction, as the market is expected to reverse at any time due to the weak trend. Momentum trading is dependent on three important factors –
- Volatility refers to the price change degree of a particular currency pair.
- Time frame refers to the number of periods a trader considers while momentum trading.
- Volume refers to the amount of the currency pair traded in the market in a given time frame.
Types of momentum
Time series momentum
Time series momentum compares the performance of a currency pair to its own performance in the past. It gives a buying signal if the comparison provides a result that the current price momentum of the currency pair is stronger than its historical movement. However, when the comparison shows that the current performance is weaker than the historical performance, it signals to place orders opposite to the existing trend direction or hold onto the trades until a stronger trend occurs.
Cross-sectional momentum
Cross-sectional momentum refers to the comparison of the currency pair price performance to the performance of other currency pair prices in the same portfolio. When the comparison provides a result in which the currency pair being compared is performing better than the other currency pairs in the portfolio, it signals that its existing trend is stronger. Hence, more long orders should be placed during an uptrend, and more short orders should be placed during a downtrend. However, when the currency pair being compared is not performing better than the other currency pairs, short orders should be placed during an uptrend and long orders during a downtrend. This is because there is an expectation of the trend reversing.
How does momentum trading work?
Momentum trading enables traders to place entry or exit orders in the market in the short term. It assumes that when a currency pair’s price has been increasing for a while, it will continue to increase in the future and vice versa. During a continued uptrend, traders are signalled to place long orders with an expectation of the market continuing in the same direction. However, if the market has been trading in a downtrend, traders are signalled to place short orders with a continued downtrend expectation. Similarly, if the market has been trading in the uptrend for a while but starts making new lows, it signals to the trader that the market is losing its momentum. This is when traders are signalled to exit their long orders and enter short orders with a downtrend expectation. On the other hand, when the market has been trading in the downtrend for a while but starts making new highs, it signals that the market is losing its downtrend momentum. This is when traders are signalled to exit their short orders and enter long ones with an uptrend continuation.
Top momentum trading indicators
MACD
Moving Average Convergence Divergence (MACD) indicates the market momentum when the MACD line crosses the signal line. A strong uptrend is indicated when the MACD line crosses the signal line from above, signalling traders to place long orders. A strong downtrend is indicated when the MACD line crosses the signal line from below, signalling traders to place short orders.
Stochastic Oscillator
The Stochastic Oscillator compares the current closing prices of the currency pair over a period of time to track the market momentum. When the oscillator provides values above 80, it indicates that the market is overbought, and traders should place short orders as the bullish trend is weak. When the oscillator provides values below 20, it indicates that the market is oversold, and traders should place long orders as the bearish trend is weak.
ADX
The Average Directional Index (ADX) measures market momentum and future price direction. Whenever it indicates a value of 20 or more, it indicates that the market is in a strong trend and an order should be placed accordingly. Whenever the reading is below 20, it indicates an extremely weak market trend and traders should either hold onto the trades or place an order opposite to the existing trend.
RSI
The Relative Strength Index (RSI) oscillates between 0 and 100 to signal market momentum. The indicator crosses above the centreline at 50 to generate strong uptrends and signals to place long orders. On the other hand, when it crosses the centreline from below at level 50, it indicates a strong downtrend momentum and signals to place short orders.
How to trade with momentum indicators?
Momentum indicators provide traders with trading singles in trending and non-trending markets. The concept of crossovers and divergences helps in confirming these signals.
Divergence
A bullish divergence refers to a market momentum where the currency pair prices make lower lows, but the momentum indicator makes higher lows. This indicates that the currency price is falling, but the market momentum is getting faster and can reverse at any time. Hence, it indicates that long orders should be placed due to an expected bullish reversal. A bearish divergence refers to a market momentum where the currency pair prices make higher highs, but the momentum indicator makes lower highs. This indicates that the currency pair is rising, but the market momentum is getting slower and can reverse at any time. Hence, it indicates that short orders should be placed due to an expected bearish reversal.
Crossovers
Trading signals are confirmed when the momentum indicators cross their middle lines from above or below. Whenever the indicators cross their middle lines from above, it generates a strong uptrend signal, and whenever they do so from below, it indicates a strong downtrend. During strong uptrends, traders receive confirmed buying signals, and during strong downtrends, traders receive confirmed selling signals.
Top momentum trading strategies
Moving Averages Momentum Strategy
The Moving Average momentum strategy is one of the simplest and most widely used strategies. It consists of a short-term moving average (50 periods) and a long-term moving average (200 periods). The crossover between these two moving averages provides momentum signals in the market.
- When the long-term moving average crosses the short-term moving average from below, it is a golden cross that indicates a continued bullish price trend and signals to place long orders.
- When the long-term moving average crosses the short-term moving average from above, it is a death cross that indicates a continued bearish price trend and signals to place short orders.
Day Trading Strategy
The day trading strategy in forex refers to buying and selling currency pairs on the same day by analysing their short-term price charts. When a currency pair price looks to be peaked, it signals that there is a strong uptrend, and long orders can be placed. On the other hand, when the currency pair prices look slashed or approach their low-price levels, it signals that there is a strong downtrend, short orders can be placed. Day trading strategies work best while considering market volume with momentum indicators. When there is a high volume of a traded currency pair in the market, It is confirmed that traders can place an order along with the existing market trend. However, if a currency pair has less volume in the market during a particular time frame, traders are signalled to place an order opposite to the current trend.
Multiple Currency Pair Strategy
In this strategy, traders choose more than one currency pair that has moved in a strong uptrend or downtrend in the last few time periods. Let us consider the time period to be 14 periods. When traders select currency pairs that have strongly traded in the upward direction for the last 14 days, they place long orders for all the currencies together to benefit from the existing direction. However, if any pair amongst the selected pairs loses momentum, they can short that trade while placing long orders for the other and benefit from both rising and falling markets. On the other hand, when traders select a pool of currency pairs that have traded in the downward direction for the last 14 days, they place shortly today for all the currencies together to benefit from the existing downtrend. However, if any pair amongst the selected pairs loses momentum, they can long the trade while placing short orders for the others and benefit from both rising and falling markets.
Flags Strategy
Flags in the forex market are areas where there is an expected temporary reversal in the existing trend after a sharp price movement. There are two types of flags that form in the forex market: bullish flags and bearish flags.
- Bullish flags occur when the currency pair prices have made a strong move in the upward direction, traded around the price for a while and reversed towards the downtrend temporarily, followed by a continued bullish movement. This signals traders to place a short order at the top of the flag (during the temporary bearish reversal) or a long order after the temporary downtrend ends.
- Bearish flags occur when the currency pair prices have made a strong move in the downward direction, traded around the price for a while and reversed towards the uptrend temporarily, followed by a continued bearish movement. This signals traders to place a long order at the bottom of the flag (during the temporary bullish reversal) or a short order after the temporary uptrend ends.
Breakout Strategy
The breakout momentum strategy refers to placing orders during a strong existing trend that breaks through its support or resistance levels and continues moving in the same direction, signalling an even stronger trend. This strategy consists of a pattern with both green and red candlesticks that occur during high volume.
- A bullish breakout refers to a currency pair’s price movement in a strong uptrend moving beyond its resistance level and continuing in the same direction, signalling to place long orders to profit from the strong uptrend momentum.
- A bearish breakout refers to a currency pair’s price movement in a strong downtrend moving below its support level and continuing in the same direction, signalling to place short orders to profit from the strong downtrend momentum.
Trade the existing trends with momentum trading strategies
Momentum trading maximises your investment returns by chasing the market’s strong trend directions. You can start trading with Blueberry, a forex trading platform today and employ one of more momentum trading strategies to your trading charts along with technical indicators to receive confirmed market signals. Sign up for a live trading account or try a demo account.
Disclaimer:
- All material published on our website is intended for informational purposes only and should not be considered personal advice or recommendation. Traders should carefully consider their objectives, financial situation, needs, and level of experience before entering into any margined transactions.