What is momentum trading?
Momentum trading is the practice of buying and selling assets according to the recent strength of price trends. It is based on the idea that if there is enough force behind a price move, it will continue to move in the same direction.
When an asset reaches a higher price, it usually attracts more attention from traders and investors, which pushes the market price even higher. This continues until a large number of sellers enter the market – for example, when an unforeseen event causes them to rethink the asset’s price. Once enough sellers are in the market, the momentum changes direction and will force an asset’s price lower.
Momentum traders will seek to identify how strong the trend is in a given direction, then open a position to take advantage of the expected price change and close the position when the trend starts to lose its strength. A momentum trader doesn’t necessarily attempt to find the top and bottom of a trend, but instead focuses on the main body of the price move. They aim to exploit market sentiment and herding – the tendency for traders to follow the majority.
Momentum in finance is based on the following key factors: