Momentum Trading:
Conversely, the same watchers have seen a stock fall and speculated that it will continue to fall. Momentum trading draws on some of our most basic analytical skills. We have all seen a rising stock chart and have, in our mind’s eye, drawn a continuing rising line beyond the point where the chart currently ends. It is this imaginary line that draws us to momentum trading. The idea is simply that a rising stock will continue rising and a falling stock will continue falling.
So, is momentum trading a losing strategy? Certainly not. Experienced traders can make good use of momentum trading because they are better at spotting the trends that will last and disregarding those that will not. Unfortunately, inexperienced traders often latch onto momentum trading and pay the price. The key to momentum trading is to spot trends very early. The earlier you can identify a trend, the more likely you are to benefit from it. If a stock was trading at $.15 last week and is trading at $.45 this week, there is a very real possibility that the rise may be over and you may have already missed out on the opportunity to buy. Conversely, if your stock was at $.45 last week and is trading at $.15 this week, there is a very real possibility that it has exhausted its downward momentum and if you sell now you may be doing so at the worst possible time. Identifying these trends often implies an overall understanding of the market and its underlying forces. Without this understanding you are left to guess as to which trends are for real and which ones will dissipate by the end of the day or the end of the week.
Now that we have given you this warning about momentum trading we should also tell you there is one method of momentum trading that is generally much more successful. We will call it reverse momentum trading. In reverse momentum trading you do exactly the opposite of the momentum trader. As a stock, or the market in general, begins to fall you become more anxious to buy and much more wary about selling. As a stock, or the market in general, begins to rise you become more wary about buying and much more anxious to sell. Even in a bull market stocks do not continually rise forever and they do not continually fall in a bear market. So the longer you see things going in one direction, the more likely it is to reverse itself soon.
Bear markets are eventually offset and corrected by bargain hunters and bull markets are eventually dragged down by profit takers. With this in mind, dropping share prices should be your cue to buy. If you buy and prices continue to drop, do everything you can to buy more. The more shares you buy at lower prices, the lower your average cost per share will be and the sooner you can sell for a profit when the market begins rising again. The faster the market rises, the more wary you should be of unchecked buying. Traders flush with higher portfolio values will eventually look to cash in on some of those paper profits and those actions may eventually drag down the market. Under these circumstances you want to make sure that you get a chance to grab your profits so selling should be on your mind.
Reverse momentum trading will immediately put you into an elite group of very wise traders During bear markets the true trading professionals are not frantically trying to sell off their portfolios. They are bargain hunting. It is as though the entire stock market has gone on sale. During bull markets those same professionals are looking to cull profits from those stocks that may be at or near their apex. Even if they guess wrong and the stock continues to rise after they sell, they still made a profit.
