swing trading

Momentum Stocks - Meaning and How Traders Use It

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When it comes to the stock market, sometimes you might hear the term "momentum stocks" mentioned. Momentum refers to a stock indicator that is popular among active stock traders.

This article will explain what a momentum stock is and how traders might be able to benefit from finding one.

 

What Exactly Is a Momentum Stock?

The term "momentum stock" refers to a stock that has just exhibited a significant upward price movement. A momentum stock's price is volatile.

Momentum can be measured in different ways.

One way is to look at its recent price fluctuations and compare them to its average historical fluctuations. If the most recent price fluctuations are higher than average, and those price fluctuations have been in a positive direction, then the stock might be considered a momentum stock.

Another way is to look at its average price fluctuations as a percentage of its stock price. If the average range of its recent price fluctuations is a high percentage of its stock price, and those price fluctuations have been in a positive direction, then it can be said to be a momentum stock.

One useful indicator for defining a momentum stock is average true range (ATR). It calculates the average amount that the price of a stock moved in a period over a given length of time.

Since the ATR captures the range of price fluctuations, it can be used to define a stock's momentum.

 

 

That image is a graphical icon that helps demonstrate what price momentum might look like on a stock chart. Each of the green bars represents the price bars on a stock chart.

You can see how the two recent bars represent 1) an increased range of price relative to the first two bars and 2) upward price movement. This could characterize the stock as a momentum stock.

 

What Does a Momentum Stock Look Like On A Stock Chart?

The image below is an example of a stock chart where the stock is momentum.

 

 

You can see that there was a big surge in price in the most recent price bar, and that surge was in a positive direction.

 

How Do Traders Use Momentum Stocks?

Momentum stocks offer the potential for some big price movements.

When stocks have that sort of potential, they can draw the attention of active traders. Many active traders look for stocks that can exhibit a big change in price in a short period of time.

This gives traders the potential to generate a large return on account in a short period of time. By the same token, momentum stocks also come with more risk since the price can also go against their position abruptly.

 

Is a Momentum Stock Bullish or Bearish?

Momentum stocks are often considered bullish since the price is surging upward. Some traders anticipate that the price momentum will continue, and might therefore buy the stock.

Some traders see momentum stocks as being due for some price reversion, meaning they expect the stock to eventually gravitate back toward its historical average. Those traders might consider shorting stocks that have exhibited a surge in price momentum.

 

How Do You Find Momentum Stocks?

You can find them by using our Momentum Stocks scanner. It's a free tool we offer here at Stock Market Guides. It uses our proprietary scanning technology to find stocks that are in a bull flag chart pattern.

Here's how the scanner results look:

 

That tool ensures that you don't have to waste time flipping through stock charts manually to find momentum stocks.

 

Example of a Momentum Stock Trading Strategy

For this example of a momentum stock trading strategy, we're going to use a daily chart, where each price bar represents one day of price activity. That means it would be a swing trading strategy where the trade is designed to last more than one day but not for the long haul.

 

Entry for the Momentum Stock Trading Strategy

The entry for this Momentum Stock trading strategy will be as follows:

The entry criterion for our Momentum Stock trading strategy is very simple.

 

Exit for the Momentum Stock Trading Strategy

There are a lot of possibilities here for the exit.

For any given trading strategy, it can be helpful to define three different criteria for the exit: profit target, stop loss, and time limit.

Not everyone uses all three, and that's totally fine. Ultimately, you can set these values however you want. But for the purposes of this strategy example, we will define all three:

 

1. Profit Target

We will set the profit target at 1.5 ATRs away from the entry price.

ATR is an indicator in the stock market that measures a stock's recent price volatility. Most trading platforms have it available as an indicator you can enable.

Our profit target criterion indicates that we will take the ATR value of the stock, multiply it by 1.5, and add it to the price we paid when we bought the stock. That will be our profit target and we can set up a sell limit order at that price.

2. Stop Loss

We will set the stop loss at 2 ATRs below our entry price. This means we take the ATR value of the stock, multiply it by 2, and subtract it from our entry price.

That will be our stop loss and we can set up a stop order at that price.

3. Time Limit

We will set the time limit as one week since this is a swing trade. If the stock has not hit either the profit target or stop loss by the time limit, then we will close the trade manually at the opening bell seven calendar days after entry.

 

How Well Does Buying Momentum Stocks Actually Work?

The idea of a momentum stock trading strategy sounds nice to many people because it offers a clear, easy-to-understand way to find a trade setup.

But does it actually work? Can traders indeed generate profits by trading momentum stocks?

That's exactly what our company can help answer for you, since our scanner technology has allowed us to do our own research on that precise question.

The answer is that trades based on momentum stocks are not always profitable, but many times they are. For certain stocks, they might have a particularly strong track record of success according to our backtest research.

Here is some data that shows how a proprietary momentum stocks trading strategy we created has performed historically according to backtests:

 

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Anyone who signs up for our swing trading scanner service will be able to see stocks that qualify for that trading strategy in real time.

 

Learning More About Momentum Stocks

You can contact us any time if you would like to ask any questions about momentum stocks or anything else related to the stock market.