Momentum Trading Requires a Disciplined Approach for Quick Entry/Exit

Momentum trading is a term that is often attributed to many trading strategies involving the use of momentum indicators to guide entries and exits in the forex market.  An often heard quote among technical analysts is that, “Price frequently lies, but momentum generally speaks the truth.”  Professional traders learn early on to trust momentum over price since the rate of acceleration in prices correlates to trend continuance for at least a period of time long enough to create a window of opportunity.  Moving quickly and adroitly in the market requires experienced hands and a disciplined approach.

Opportunities typically arise during periods of sideways action in the market when institutional players literally bounce back and forth in a “box” waiting to determine their next move, either a positive breakout or a negative reversal.  It is at these moments when momentum gathers to break through the limits of the “box” that traders prepare to execute their momentum driven trading plans.  Profit targets fall in the “50 pip” range, with quick entry and exit parameters.

For example purposes, let’s review the following chart for the “AUD USD” pair:

There are a variety of momentum indicators in use today.  The MACD Histogram and the RSI, “Relative Strength Index”, are shown above.  Many traders also favor “Slow Stochastics” or the “Commodity Channel Index”, or CCI, for this purpose, but recommended “best practice” is to choose one, or two if confirmation makes you feel better, and then focus on developing interpretative skills around your chosen “tool”.

In the “one hour” chart for the Aussie Dollar, the formation of three range-bound “boxes” are displayed, each highlighted by the dashed parallel lines.  These periods represent the “calm before the storm” so to speak.  Momentum indicators also tend to fluctuate within boxes of their own in their respective portions of the chart, and their breakout from these boxes confirms that they are good leading indicators for changing price behavior.

The “green” circles highlight momentum “signals”.  Market breakouts can be sudden, and a trader must be adept enough to plan his actions accordingly.  For the first set of green circles, both momentum indicators broke from their respective “boxes” and produced overbought signals within the period highlighted.  The move in price was nearly 150 “pips”, triple the standard profit target for this strategy.

The second occurrence of this “breaking out of the box” scenario is in the opposite direction, but once again, nearly 150 “pips” of opportunity.  In this case, you would be electing to go “short” on the Aussie Dollar.  The sideways action set up this trade until the MACD Histogram made a move south and the RSI confirmed the imminent reversal.  It is not necessary to perfectly time these moves.  Most traders will settle for a bit of delay in entering, and then ride the wave of momentum until the requisite oversold or overbought condition is foretold.  Quick in, quick out, and no hesitation in the decision-making process, the sign of a disciplined approach to trading and necessary at all times for success in forex trading.

The hallmarks for momentum trading are having the patience to wait for your best entry opportunities, and then following through with deliberate actions based on a step-by-step trading plan, honed to perfection with hours of practice on a demo account system.  This plan must also include prudent placement of stop-loss orders to protect your downside, with appropriate attention given to periods when these measures may not be effective.

No trading strategy is perfect, but momentum-trading models tend to point the trader away from low-probability set-ups and to better potential opportunities.