# Understanding Momentum Trading: Definition, Tools, and Risks

## What Is Momentum?

Momentum in trading refers to how quickly a [security's](https://www.investopedia.com/terms/s/security.asp) price changes, capturing the momentum of its trend. This strategy leverages the speed of price changes to identify trends for trade opportunities, often using [oscillators](https://www.investopedia.com/terms/o/oscillator.asp) in [technical analysis](https://www.investopedia.com/terms/t/technicalanalysis.asp) to spot these potential moves.

### Key Takeaways

*   Momentum in trading refers to the rate of acceleration of a security's price or volume, often used to identify and capitalize on trends.  
    
*   Momentum trading strategies aim to benefit from following market trends, buying securities that are rising and selling them when they appear to peak.  
    
*   Technical analysis tools, such as oscillators and trend lines, are commonly used to measure momentum and guide trading decisions.  
    
*   Momentum investing involves risks, including unexpected market reversals and changes in investor sentiment, which can lead to financial losses.

## How Momentum Shapes Trading Strategies

Think of it as the momentum of a train: When a train starts up, as it accelerates, it moves very slowly. Once it gets up to speed, it stops accelerating but remains traveling at a higher velocity. At the end of the trip, the train decelerates as it slows down, but it can take many miles of track to apply the brakes before finally coming to a complete stop. For the momentum investor, the best part of the train ride is in the middle, when the train is moving at its highest velocity.

Momentum investors like to chase performance. They attempt to achieve [alpha](https://www.investopedia.com/terms/a/alpha.asp) returns by investing in stocks that trend one way or another. Stocks trending up are referred to as hot stocks. Some are hotter than others (as measured by growth over a period of time). A stock that is trending down is cold.

[Investors](https://www.investopedia.com/terms/i/investor.asp) can use momentum as a trading technique that seeks to profit from the [herding behavior](https://www.investopedia.com/terms/h/herdinstinct.asp) of market psychology. Rather than "buy low, sell high", momentum trading follows a strategy of "buy high, sell higher". Once a momentum trader sees acceleration in a stock's price, earnings, or revenues, the trader will often take a long or [short position](https://www.investopedia.com/terms/m/momentum_investing.asp) in the stock in the hope that its momentum will continue in either an upward or downward direction. This strategy relies on short-term movements in a stock's price rather than [fundamental value](https://www.investopedia.com/terms/t/technicalanalysis.asp).

When applied, an investor can buy or sell based on the [strength of the trends](https://www.investopedia.com/ask/answers/012915/what-are-best-technical-indicators-complement-relative-strength-index-rsi.asp) in an asset's price. If a trader wants to use a momentum-based strategy, he takes a [long position](https://www.investopedia.com/terms/l/long.asp) in a stock or asset that has been trending up. If the stock is trending down, he takes a [short position](https://www.investopedia.com/terms/s/short.asp). Instead of the traditional philosophy of trading—[buy low, sell high](https://www.investopedia.com/articles/investing/081415/look-buy-low-sell-high-strategy.asp)—momentum investing seeks to sell low and buy lower, or buy high and sell higher. Instead of identifying the continuation or [reversal](https://www.investopedia.com/terms/r/reversal.asp) pattern, momentum investors focus on the trend created by the most recent price break.

## Essential Insights Into Momentum Trading

###  Key Tools for Effective Momentum Trading

Some [tools for momentum investors](https://www.investopedia.com/ask/answers/012015/what-are-differences-between-relative-strength-index-rsi-stochastic-oscillator.asp) help to define the trend, such as the trend line. A trend line is a line drawn from the high price to the low price, or vice versa, over a given time period. If the line is up, the trend is up and the momentum investor buys the stock. If the trend line is down, the trend is down and the [momentum investor sells the stock](https://www.investopedia.com/terms/k/know-sure-thing-kst.asp).

In this way, momentum investing is purely a [technical indicator](https://www.investopedia.com/terms/t/technicalindicator.asp). Though "momentum" can refer to fundamental measures of performance, such as revenue and earnings, it is most commonly used in reference to historical asset prices as a technical indicator.

### Navigating the Risks of Momentum Trading

Just like any other trading style, there are risks that come with momentum trading. Using this technique means trading based on others' actions in the market, and trends are not guaranteed. Be ready for unexpected reversals or corrections. This can happen because of unexpected news or changes in investor sentiment in the market.

## The Bottom Line

Momentum in trading refers to the rate at which a security's price changes, allowing traders to profit from sustained trends. Momentum traders capitalize on speed and direction, often utilizing technical indicators like oscillators to identify potential trends.

This trading strategy involves buying rising stocks and shorting falling ones, hoping the trend continues rather than focusing on fundamental values. However, it's crucial to recognize the risks of momentum trading, as it relies on market sentiment and is vulnerable to abrupt reversals. Traders should be prepared for sudden shifts due to unexpected news or changing investor psychology.

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> 2.  Financial Industry Regulatory Authority. “[Short Interest – What It Is, What It Is Not](https://www.finra.org/investors/insights/short-interest).”
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> 4.  Investor.gov. “[Stocks](https://www.investor.gov/introduction-investing/investing-basics/investment-products/stocks).”