On an invented price path, the price rises strongly, stalls and then jerks down and up without going anywhere, with a trade whenever it has moved far over the last fourteen points: 5 trades are marked, one closed ahead and 4 closed behind.
A triangle marks where a trade opens and points the way it was taken. A green dot is a trade closed ahead, a red dot one closed behind. The path was invented to show how the approach behaves, including where it goes wrong. It is not market data and it proves nothing.
Also searched asmomentum strategy · rate of change strategy · relative strength trading · buy high sell higher
A description, not a recommendation
This is a description of an approach people use. It is not a recommendation. No approach works in every market, nothing here has been shown to be profitable, and the chart is invented.
The idea
Momentum is the observation that what has risen recently has, in many studies of many markets, tended to go on rising for a while, and what has fallen has tended to go on falling. Momentum trading acts on that: it buys strength and sells weakness. It differs from trend following mostly in how it measures, comparing the price now with the price a set time ago, and often comparing several markets with each other.
Usually heldDays to months · others held about as long
The rule, as people usually state it
As usually stated: measure each market’s change over a look-back period, for example the last three, six or twelve months. Hold the ones that have risen most, or any that have risen by more than a threshold; sell short, or simply avoid, the ones that have fallen most. Review at a fixed interval and replace whatever no longer qualifies. On a single market the short form is: long while the price is above where it was N bars ago, out or short when it is below.
What it needs from a market
- Moves that persist for longer than the look-back period takes to notice them.
- Several markets to compare, if the relative form is used.
- Acceptance of sharp reversals, which are part of the record of this approach.
What it costs
It depends on the review interval. A monthly review of a few markets trades little. A short look-back on an intraday chart trades constantly and pays the spread each time. Momentum also buys after a rise, when a market is busiest and often most volatile, so stops need to be further away and the position smaller for the same risk.
When it fails
- At turning points. The approach is fully invested in what has been rising at the moment it stops rising, and published studies of momentum describe sudden, steep losses of this kind.
- In a market that jerks up and down without direction: each move is large enough to enter and reverses before it pays.
- When many traders hold the same strong markets and leave together.
The mistakes people make with it
- Confusing a large rise with a reason to expect more of it. The measure says what happened.
- Choosing the look-back that gave the best past result.
- Buying the single strongest market with a large position.
- Having no rule for getting out other than hoping the move resumes.
In the rule bench
The rule bench cannot express momentum as described. It has no “change over the last N bars” entry and tests one market at a time, so it cannot rank markets. The breakout page is its nearest relative.
Questions people ask
- Does momentum trading work?
- Nothing on this page shows that it is. The page describes what people do and why. Published research on trading rules is mixed, results that looked good in one period have often faded in the next, and costs remove much of what remains. The loss figures that regulators require firms to publish show that most retail accounts trading CFDs lose money.
- What is the difference between momentum and trend following?
- They overlap. Trend following usually reads one market against its own averages or its own highs and lows. Momentum usually measures the change over a fixed period and often ranks markets against one another. Both buy what has been rising.
- What is a momentum crash?
- A sharp loss for momentum positions when markets reverse: what had fallen most rebounds fastest and what had risen most falls. Academic studies of momentum in shares describe such episodes after steep market declines.
The words on this page
An explanation for study. It is not advice, a recommendation or a forecast. This is a description of an approach people use. It is not a recommendation. No approach works in every market, nothing here has been shown to be profitable, and the chart is invented.