What is momo trading and what does momo stand for? These are common questions we see all the time.
Although there are many different types of trading strategies available, ‘momo’ trading strategies have become more and more popular in current markets.
In this post, we’ll discuss what momo trading strategies are, how you can use them to trade stocks, and how they differ from other styles of trading.
What does Momo stand for?
Momo simply stands for momentum.
The term momentum is borrowed from Newton’s first law of motion, also known as the Law of Inertia. The law states that an object will remain at rest or move at a constant speed in a straight line unless an external force is applied to it.
According to the law, an external force is needed to change the direction or speed of a spacecraft. This force could be supplied by the engine of the spacecraft. An external force is needed move the pen on your table. You could supply the force by pushing the pen.
In the day trading world, momentum basically refers to the level of aggressiveness in the market.
When shares of a given company are showing strong positive momentum, traders are jumping over each other to buy.
Like in Newton’s law, a stock in motion tends to remain in motion rather than reverse. Momo trading is based purely on the volume and trend in a certain direction.
Simply put, momentum in the market has less to do with the fundamentals of economics and balance sheets, and more to do with the faddishness of human behavior.
In essence, traders often jump to the stocks that have been rising, which tends to push them further.
Momo, or momentum, traders don’t determine whether the stocks are cheap or expensive in theory or analyze why technology stocks, for example, are on a winning streak recently.
Momo traders hop on the bandwagon, aiming to close their positions before the inevitable train wreck that brings the journey to an end.
Let’s take a look at the difference between Apple (NASDAQ: AAPL) and Virgin Galactic (NYSE: SPCE) in the following chart:
While AAPL is slowly grinding upward in price, gaining more than 5% in less than three weeks of trading, SPCE was hitting new highs on an almost hourly basis, with shallow pullbacks and huge rallies.
During this period, the buyers in SPCE were willing to pay just about any price to have the stock in their portfolios. That is to say, SPCE’s rate of change was faster.
Momentum Trading Indicators
Momentum indicators help to show the movement of price over time and how solid the movements are or will be, irrespective of the direction the stock moves, up, or down.
They are also specifically essential, as they help traders identity points where the stock can and will reverse.
While some traders rely solely on volume and price to measure and utilize momentum, there are numerous indicators that you can use. Some of the most common momentum indicators include:
- Rate of Change (ROC)
The Rate Of Change (ROC) indicator is a mathematics concept: It is simply a calculation that shows how one value changes compared to another. The rate of change technical indicator compares price changes to each other.
According to StockCharts, the rate of change indicator is calculated using the following formula:
ROC = [(Close – Close n periods ago) / (Close n periods ago)] * 100
- Relative Strength Index (RSI)
Developed in the late 1970s by technical analyst Welles Wilder, the Relative Strength Index (RSI) indicator compares the current returns with losses over a period of time to measure the rate of change in a momentum or in price movements.
RSI is considered to be a momentum indicator because, like ROC, it compares the current price change to recent price changes. The higher the reading, the faster the price is changing.
- Moving Average Convergence-Divergence (MACD)
Moving Average Convergence Divergence indicator tells you when the direction of two moving averages are converging on each other (going in the same direction) and when they are diverging (telling different stories).
One way to use this momentum indicator is to pay attention to its short term swing lows and highs. This allows you to compare the relative momentum of price swings to each other.
How Momo Trading Differs from Trend Following
As mentioned earlier, traders generally use momentum trading strategies to capture strong moves in short time frames usually for not more than a few hours or a few days.
Generally, the traders are very focused on only several trades at a time at most and scan a big watchlist for a few signals.
By contrast, trend followers manage portfolios for exits and entries across diversified stocks responding to signals that help them to capture the returns in long-term trends.
This allows them to be on the right side of infrequent outlier events that result to huge returns through huge parabolic movements in one direction over a long period of time.
Momentum Trading in the Stock Market
To pull off momo trading in the stock market, there are a few principles you need to follow:
- Use trailing stop-loss orders in order to ride trends
- Develop a ranking system to determine which stocks to buy
- Stock should have high relative volume
- Have predetermined profit targets
- Follow the trend
Momo trading is the ideal style of trading for traders looking to capitalize on sharp price movements quickly.
But it is not a style for risk-averse traders. You can make large percentage gains in a short period of time, but you also can suffer massive losses in the same time frame.
Therefore, you need to have the right strategies compatible with your personality, so you are able to execute your trades correctly.
Successful momo traders understand their strengths and weaknesses, and structure their strategy based on both.
Credit: Warrior Trading