What Is Momentum Trading? – Trading Tutorial

Momentum can be a single or multiple candles (price candles). We see in the chart large or growing candles or several bullish/bearish candles that appear one after the other. Large candles without a wick or with a small wick are often called high momentum candles.

Momentum thus refers to the increase in the “momentum” of a price movement. If the speed or force of a price movement increases significantly, this is called increasing momentum.

In the chart above, the share price of Dr. Hoehnle AG shows a nice bullish Momentum Candle.

This long price candle is characterised by the fact that it has a much greater fluctuation range than the price bars before it. In addition, this candle also has a significantly higher volume than the average volume.

High momentum paired with high volume, which moves the price, are good indications for further momentum. As can be seen in the example here, the momentum also continues. As long as bullish candles occur, there is no reason to close the position in momentum trading itself. Thus, momentum candles are often the initiation of major trends.

Especially after important news, one can often observe how the news and the emergence of the Momentum Candle under high volume then the momentum continues and a trend is established (also known as Pivotal News Point).

This is because the creation of a Pivotal News Point often changes the future growth prospects for the company. As a result, the interest of more and more investors is aroused and stock analysts adjust their ratings and price targets. Thus, relevant fundamental news is often the beginning of a trend (or the end).

Jesse Livermore was a momentum trader

Jesse Livemore, one of the most famous stock exchange speculators, was also a momentum trader.

He especially liked to use the following approach:

Stocks that open with a gap based on news, followed by a large momentum candle with high volume. The point of the gap opening is called the Pivotal News Point. If the price stays above the point and breaks out to a new high, Jesse Livermore liked to strike. This strategy still works today.

The share can also consolidate for some time and then break out upwards.

But it is even best if the share takes the low of the pivot point out again (stops are taken and the market clears up) and then breaks out to new highs. A simple but effective approach for momentum traders.

But besides Jesse Livermore, there are also some well-known momentum traders.

The best Momentum Traders of our time

The current four best known momentum traders are the following:

  • Mark Minervini – Achieved a performance of 36.000%
  • David Ryan – Achieved a performance of 1,379
  • Dan Zanger – Made $11,000 into $18 million in less than a year.
  • Mark Ritchie II – Achieved over 1,000% since 2010
  • The SEPA strategy of Mark Minervini

He himself describes Mark Minervini’s strategy as SEPA strategy (Specific Entry Point Analysis). This is an approach he developed himself. This method involves quantitative screening, fundamental research and qualitative analysis to identify stocks with the potential for significant value growth.

One approach to filter stocks that meet these criteria is as follows: After a fundamental screening, which filters by criteria such as profit, turnover and margin growth, moving averages (GD) are added. Here it is important that a stock shows an upward trend at all major time levels. This can be achieved by working with the three most important and well-known moving averages, namely the 50, 100 and 200 GD`s.

Share price > GD 100 and GD 200; GD 100 > GD 200; GD 50 > GD 100 and GD 200.

The longer the GD 200 moves upwards, the better (at least 1 month). The stock should also be far enough away from its 52-week low (at least 30%), and on the other hand not too far away from its 52-week high (at most 25%).

The CANSLIM strategy of David Ryan

David Ryan calls his strategy CANSLIM.

This approach originally comes from William O’Neil.

C stands for current earning (current earnings per share). This should be 25% or more and increasing.

A stands for annual earnings. These should be 25% or more in each of the last three years.

N stands for new product or service.

There are two factors to consider:

  • The company should offer a new product or service that has a significant impact on profits.
  • The stock should move from a sideways phase or consolidation to a new high.
  • S stands for supply and demand. The trading volume should be high or increase when the stock breaks out to a new high.

L stands for leader or lagged. One should focus on the leading stocks in the top sectors and avoid laggards.

I stands for institutional sponsorship (institutional positioning). The positioning of institutional investors should increase.

M stands for market indices (market indices). Dow, Nasdaq and S&P 500 should show an upward trend when buying stocks.

Dan Zanger is also a pure momentum trader

The well-known US trader Dan Zanger trades outbreaks from various chart formations, such as Flat Channel, Bullish Flag, as well as Cup and Handle.

He also uses additional volume, and this should be above average after the breakout.

If the volume does not increase after the breakout, he usually closes his position again, because it is an indication that the breakout does not want to continue, because nobody wants the stock.

In addition, he concentrates on leading stocks with a high beta factor. In addition to momentum trading, his trading style can also be described as swing trading, as he also holds his shares for a longer period of time (between two and ten weeks). In addition to stocks, he also trades deep in the money call options on the strongest stocks in the world.

Furthermore, he does not trade in bear markets and therefore acts all the more speculatively in bull markets. So it is quite possible that he sometimes bet 30% of his risk capital on a single share in very liquid stocks.

The Momentum Strategy of Mark Ritchie II

Mark Ritchie II uses the same approach as Mark Minervini. He is the son of Mark Andrew Ritchie (known from Trade like a Market Wizard and God in the Pits).

Through Minvervini’s approach, Ritchie II achieved over 100% within 6 months, winning Mark Minervini’s 2010 Triple-Digit Challenge. He has continued to be successful with the approach ever since and his performance has been over 1000% since 2010.

The four successful Momentum traders, along with over 130 Q&A’s, are also featured in the highly recommended book Momentum Masters: A Roundtable Interview with Super Traders.

Momentum vs. Trend

Many market participants also call momentum a trend. But this is not necessarily true. You have to distinguish between momentum and a trend. Often, emerging momentum is the beginning of a trend or a sign that the trend has come to an end. But momentum alone has nothing to do with a trend.

For example, a strong bearish momentum can occur in an uptrend, but the uptrend can continue. Thus, the bearish momentum is no trend. It is merely a correction. Trend following traders would not follow this downward correction. Momentum traders, however, would. They follow the momentum. Of course, the odds increase significantly if you also trade with the trend. But those who trade pure momentum can also participate in corrections.

One should also keep in mind that the biggest profits are always made in uptrends. Because a share can fall by a maximum of 100%, but theoretically rise infinitely.

Tesla share with Momentum Trading

First a high bearish momentum candle with high volume appeared. However, the upward trend was still active and continued. Shortly afterwards, the share even marked new highs.

But this big red candle had already caused fear among most participants.

The share made a new high in the uptrend and a strong bearish momentum followed. This momentum was not created by a single price candle, but was followed by more bearish candles with high momentum and under high volume. The previously aroused fear of investors was confirmed, which resulted in this strong bearish momentum.

The momentum was bearish, but the trend remained bullish.

Afterwards, the old high was repeated once again. However, as no new high could be reached and a double-top formed, the stock was sold off again and another bearish momentum was created (in an uptrend).

Momemtum Trader and trend sequence Trader

So we see here that momentum should not be confused with trend.

Momentum may be a “trend” in smaller time frames, but in the larger time frames it is just a momentum. Furthermore, momentum and trend can also occur in the same direction. This is often the better option and is preferred by many momentum traders. But one should be aware of the difference.

Not every momentum trader is also a trend following trader. But a Momentum Trader makes the biggest profits when a strong trend is established through the emergence of the Momentum. With the Momentum approach, one has the advantage of being early in a movement and thus the possibility of achieving a good performance.

Also the exit is usually clearly defined in momentum trading. One expects a timely continuation of the momentum. If this fails to materialize, you exit again. This is a good way to limit your losses and a lower hit rate is sufficient to achieve a good performance nevertheless. Mark Minvervini himself says that the number of his loss trades is significantly higher.

Conclusion of this article about Momentum Trading

Momentum trading is still one of the most successful trading approaches in the world today.

There are numerous successful traders who have achieved or are achieving outstanding results with the help of Momentum Trading.

The advantage lies clearly in the simplicity of the application and the duplicability of Mometum Trading strategies. These work in all markets, as well as in the Forex market, etc. With Momentum Trading in the Forex market there is only no additional indication by the volume, but the principle is the same.

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