My Momentum Trading Strategy
Nearly all momentum strategies incorporate indicators but my strategy is more of an incorporation of my processes and indicators that lead to buy and sell signals. I follow a structured approach to trading.
- Determine a trading bias, either short or long.
- Find the best market sectors to trade using Finviz.com. What sectors are best to change could change day to day but is more likely to change week to week or perhaps month to month.
- Hone down which stocks in this sector or sub-sector look most promising.
- After visually identifying which stocks to focus on in the hundreds of stock charts I have on stockcharts.com I use my technical indicators to identify entry and exit points.
Defining the Momentum Indicators
I have spent hundreds of hours learning different technical indicators for momentum stocks and wasted a lot of time using more indicators than what was needed with the thinking the more indicators I use the more reliable the trade will be. After much trial and error I realized this only complicated and confused the decision making process. I am a believer of the “KISS” method or “Keep It Simple Stupid”. This has streamlined the process of trading and has worked extremely well for me. After visually identifying a stock that appears to be setting up, I use a combination of the MACD, Stochastics, Moving averages, Trend lines and Support/Resistance to determine if a trade should really be made and what the entry and exit point needs to be. I use a combination of these indicators because using them all on the same trade would not be applicable.
Support and Resistance
While not technically being an indicator, using Trend Lines along with Support and Resistance is critical when visually finding stocks and are used in conjunction with the indicators described above.
- One of the critical factors for me is not just that resistance is broken but whether or not this break is done with strong, average or less than average volume. The break should be with at least 20% higher daily volume than the recent average. This tells me that traders are confident in this break and therefore I can be to. If the break should fail it should also do so on strong volume or it will fail slowly on average volume, either case would give me time to get
The video below helps explain Support and Resistance and I will go over how I use it in my trading system a little later.
When a trend is broken, it is important to not impulsively take a momentum trade but rather to take time to consider a trade. The questions I usually ask my self are now that the trend has been broken:
- What are the stochastics telling me? Is the stock overbought and needs time to consolidate before I take a trade
- When a trend line is broken their is sometimes a retracement back to that trend line or area of support (as described from above section), should I wait for this retracement and then buy off the bounce? Stochastics could now be oversold at this point or could just be lower on the indicator and be trending up, either scenario would set up a nice trade.
- When this important trend line was broken was it done so with strong volume? A break with strong volume would make me more confident of the trade and should also make the trade less likely to fail.
It is ideal but not necessary for me to buy a stock when it is oversold and curling up or at least on the low end of the indicator but turning up. The indicator needs to be curling up because that indicates the stock could beginning an upswing. It is not absolutely necessary to take a trade when it is not completely oversold or at the low end of the indicator because stocks that are in a strong uptrend can get overbought and stay overbought for a considerable amount of time. So even if it is overbought it could still be a buy if the chart and volume look good and the stochastics are curling up.
If a momentum stock recently experienced a strong move up, consolidated a bit and is now about to break that recent resistance, the stock could just be starting a new leg up and this could be a good point to take a new trade but it would likely still be overbought because it has been in such a strong uptrend.
It is important to recognize that you could take advantage of the next leg up and benefit significantly but you need to be cautious with your stop order because a stock that has had a big swing up especially when it occurred quickly will eventually fall and that fall is likely to be faster than its rise. I would always recommend a STOP LOSS rather than a STOP LIMIT order in this instance because a stock in free fall often jumps over prices so your STOP LIMIT order may not get triggered and you don’t want to ride the stock all the way down.
I use the MACD as a trend confirming indicator to verify I am on the right side of the trade. Since the MACD follows price action it is generally not a good indicator to use when you are trying to decide entry and exit points.
Interesting note – Once you learn the details about how to use the MACD take a look at a yearly chart of the Dow Jones Industrial Average with this indicator.
Let’s Put It All Together
- Determine whether or not I am Bullish or Bearish. I am Bullish.
- Since I am Bullish, I find the sector or Industry with money moving into it.
- I review my saved charts in the Sector/s I am interested in.
- After I find promising charts set-ups, I use my technical indicators determine if a stock should be purchased and what the trade should look like.
- I use alerts to notify me when a stock I am following reaches my desired price and I indicate when I set up that alert what the entry price and exit price should be.
“If your trades are not profitable at least 50% of the time, you are not a successful trader”
This is not an accurate statement. I will discuss this more in a future article.
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