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Momentum tradingWhat is Momentum trading anyways? The market often overreacts to news. There is either panic selling, or panic buying. These overreactions lead to dynamic price movements with predictable patterns. News usually come out prior to the market open, which gives you time to sort thru your momentum stocks and select the ones that look the most promising. The classic momentum trading example is a stock that has lost almost 50% of its value in premarket trading on heavy volume. After the open, it gets some more selling from people that weren’t able to sell their shares in premarket trading. Only about one minute after the opening it starts stabilizing and climbing, never seeing that first low again. It was down to almost $20 after closing at $40 the day before and is now making it’s way back to almost $30 climbing slowly all day long. That is certainly an ideal example, but believe me, I have seen many of those. However, times have changed and momentum trading certainly has gotten more difficult and good chances less frequent. It is still an amazing strategy to watch though. Momentum trading is mostly done in the first half hour of the trading day, because the momentum is clearly the strongest. There are two main categories of momentum trading strategies: Gainer: a stock that is opening with a strong gap up after receiving good news. Dumper: a stock that is opening with a strong gap down after receiving bad news. Gainers and dumpers can both be traded long as well as short. Depending on how strong their overall categories are. That’s why it is very important to follow them each day to get an idea of what to expect. The basic idea is to see if gainers and dumpers (tracked separately) are either making higher highs (following a stair stepping up pattern), or if they are making lower lows (following a stair stepping down pattern) and to trade the categories according to the patterns you see. You wont be able to always find strong and clear patterns, but other times you will notice very clear patterns, and that’s the best time to play momentum trades. Sometimes a pattern can be consistent for several months, especially the dumper pattern. Gainers and dumpers Gainers are stocks that react positive to good news. Ideally, the stock is gapping up 10% or more with strong volume in premarket trading. You can trade gainers either long or short It all depends on how strong the individual gainer is and even more important, how strong the whole gainer category is. I will stay with an example for longs here assuming that gainers are strong and make higher highs after the opening. There are two entry approaches when doing momentum trading: 1. Entry after the first uptick. 2. Entry after break of first range. 1. An entry after the first uptick means to enter a long position once the stock made its very first uptick of the day. Meaning both bid and ask are higher than the previous ones (stock is climbing). I am assuming, that after a strong gap up the stock will first receive some profit taking before getting even more buying (assuming the pattern is strong), and therefore making a long trade interesting. You have to watch your gainer very careful right after the open in order to identify the first uptick and enter your buy order right after you see the uptick. I use level 2 only to find my entry since it shows much more detail than a chart. 2. An entry after the break of the first range is a more conservative approach than the entry on the first uptick. It has the advantage that the stock is confirming its trend. By breaking to a new high there should be additional momentum coming into the stock. The downside is that you could have gotten in earlier on the first uptick and that your stop is larger. I place my stop below the low of the day. The first range is often established very, very fast, i.e. a stock opens at $48 and then falls back to $47.85 and recovers from there; this is already the first established range. This can happen within only a few seconds. My entry would be above $48 and my stop below $47.85. It is very important for this setup, that the first range is extremely narrow; otherwise, the stop is too big. When momentum trading I often will watch three or four stocks for opening range breakouts, and in the end only one will qualify for a trade by giving me a tight enough range at the open. If the stock upticks right after the open I will wait until a high is established, let the price come back and consider an entry above the high. The same strategies applied to the gainers can also be applied to stocks with ongoing momentum, i.e. stocks that run over an extended period of time. As you have noticed, the examples above were for long setups and assume that the gainer category is strong. Should the category be weak and gainers are rather closing their gaps instead of adding to their gains, you can apply the opposite and short the stock on its first downtick or go short after the first range breaks to the downside. The ideal situation to go long is a market where there is a lot of runners and ongoing momentum in strong stocks. Tracking the categories and identifying trading opportunities is not as difficult as it might seem. Simply watch gainers and dumpers for a while and write down what they are doing in the first half an hour to an hour of trading. If you notice similarities and consistent patterns, try to trade them on paper. Dumpers Dumpers can be traded just as gainers. I am looking for stocks that are gapping down at least 10% on strong volume. Overall, the category proves to be more stable and changes its pattern less frequently, which makes it easier to trade it. From winter 1999 to late spring 2000 for example the category was strong and you could have traded the first bottom long very successfully. Since the summer of 2000, the category has been very weak and overall you were much better off shorting dumpers. There were and still are very few bottom fishers in the market. Always make sure, that you don’t get involved in a stock that has extremely bad news and might get halted! OK, Enough about that! Entire book are written about Momentum trading but you have enough here to understand the concept. Now let's move on to the next chapter entitled: How to trade "GAPS". 
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