Momentum trading is much less concerned with ‘precise’ entries and more with the force and continuation of the move. Traders are not looking for the price to pull back or break out from any specific price, but merely to start moving more or less in the direction of the prevailing trend.
This type of trading is fundamentally based but also relies heavily on indicators such as moving averages and oscillators to give trading signals.
Traders will use momentum based strategies when they perceive a long term move to be taking place on the asset that they are trading. For example, if there is a significant change in the fundamentals of a nation that will result in an interest rate change, this will cause investors to act and begin buying or selling the currency of that nation in line with those changes. Other examples include geo political events that remain in place for many months and sometimes even years.
During these significant shifts, professional traders will be looking to trade these currencies over the long term, often holding their positions over a period of weeks and months.
Because of the longer term nature of this strategy traders are not as concerned about entry points and simply wait until minor technical analysis gives them an opportunity to profit from the move. A popular indicator for this type of trading includes the 200 period moving average, and very often traders will look for price to break above or below this moving average in line with the anticipated move, at which point they will enter the market and hold their positions.
Exits are generally governed by fundamentals in a similar way to entries, with traders watching the economic and geo political events very closely before deciding which trading approach they will take and how they will manage those ongoing positions.
The above was excerpted from Dean Peters-Wright: Top 5 Popular Trading Strategies published on May 29, 2013.
As a general term, momentum refers to the speed or strength of price movement. It also is the name of a specific technical study that measure the difference between today’s closing price and the closing price N days.
See also Rate of Change.