When momentum trading is executed properly with a tried and tested trading plan and proper risk control, it displays a trading method that is ofter referred to as High Probability Trading.
When analysing stocks for momentum trading, a trader measures the amount by which a security’s price has changed over a given time span.
Stocks that appear to gather momentum in a certain direction have price moves that are often caused by fastbreaking news or big-money investors, taking and dumping positions.
These momentum changes can be valuable as either a trend-following tool or a leading indicator of further price movements.
An initial momentum move may be signified by a stock that has been lying dormant for a certain amount of time. One day, this stock may suddenly jump to a new high on an increase in volume.
The rise may continue for a few days with the increased volume being sustained. This could be classified as a breakout pattern on a stock chart.
After this initial breakout, there is often a retracement in the price. This is often quoted on the news as profit taking, but could occur for any number of reasons.
If momentum picks up again after this retracement, then this can signify the start of a longer term trend as reasons for the initial burst in momentum come to light and confidence is built in the stock.
Momentum trading can be very profitable when risk is handled properly. Stop loss orders should be highly considered to manage risk as part of a successful momentum trading plan.
One person who has made a lot of money from implementing a momentum trading approach to their investment strategy is Nicolas Darvas. In his book How I Made $2,000,000 in the Stock Market, he gives an account of how he nearly went broke by trading stocks, and then how he made $2M after formulating a very successful trading plan that uses momentum trading methods.