Momentum Trading: What It Is and How To Do It

Momentum Trading: What It Is and How To Do It


Momentum Trading

Momentum traders are the guerrilla warriors of trading. In-and-out before you know it, these skilled tacticians rely on technical analysis and quick reaction time to follow market trends and capture high-speed gains.

What is momentum trading?

Described in the clip above, momentum trading is about jumping into a stock trend early in the move, and capitalizing on it before the trend completes. The trend can be bullish, or bearish — it doesn’t matter. What matters is that the trader is sure about the direction, and that they’re entering the trade with a plan. That plan should answer questions like:

  • Why am I bullish or bearish on this stock?
  • At what stock price will I enter the trade?
  • How long do I intend to be in the trade?
  • What is my potential risk and reward?
  • At what stock price will I consider taking profit on the trade?
  • At what stock price would my bullish or bearish thesis be proven incorrect?
  • If my thesis is proven incorrect, what is the largest loss I’m willing to take on the trade?

Having a plan before you enter a trade will help you to make more consistent trades, and to avoid making emotion-driven trades.

Why most momentum trading strategies are powered by options.

Momentum trading and options go together extremely well. Momentum traders want to make a quick buck following trending price action, and options are time-dependent, multi-directional instruments that benefit the most when a trader is right quickly

Additionally, momentum traders use options to leverage their potential reward while mitigating risk. For instance, you could buy 50 shares of Apple ($AAPL) at $170 per share. But you would have to risk $8,500. Instead, you could use options to replicate the risk/reward profile of that position. By purchasing an at-the-money 50 delta option, you could risk just $250 to achieve roughly the same price-appreciate per dollar-increase in Apple, without having to risk thousands. 

The catch? You’d have to be right, quickly! If short dated options aren’t directionally correct in a short period of time, they start decaying fast. But in the right hands, options can be an excellent and incredibly powerful tool for making momentum trades.

How momentum traders identify targets

Every trader is different, but most momentum traders have a few things in common with regard to how they pick their targets. First, here’s what they don’t do

They don’t judge a stock on the fundamentals, valuation, or the long-term outlook of the company — momentum traders want to be in and out of the trade long before those factors begin to matter. 

For instance, if you found a company that’s been fundamentally undervalued for years, it probably won’t change this week. Great information for investors, irrelevant for short-term traders.

But if momentum traders aren’t using fundamentals to find the best buying opportunities, what are they using in order to find potential targets? Some rely on quick-reactions to news or current events, but many utilize…

Many momentum traders rely on technical analysis

Technical analysis can be complicated, often involving the use of many different candlestick patterns and technical indicators. For the purpose of this lesson, let’s boil it down to one simple act: watching a line. Not just any line – an established line of support or resistance, called a trendline or a flatline

Here’s how a technical-analysis driven momentum trade works in practice, using a trade-plan from Market Rebellion’s TNT Options service:

Notice how the detailed plan from the clip above, created before the trade was made, answers all of the questions we described above. The why, the risk and reward, the levels to consider entering and exiting the trade. Additionally, it’s important to use ATR, or average true range to gauge the potential of a stock to continue to move. 

The bottom line

The most important line from the clip above is this: 

“This was all in your fingertips before this unfolded.” 

By identifying important trade details ahead of time, traders can learn to exploit momentum-driven moves like this using technical analysis. 

If you’re interested in following along with Market Rebellion’s momentum-driven trades, including receiving detailed trade ideas every week based on the same technical analysis featured in the clip above, check out TNT Options

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