Understanding Momentum Trading in the Forex Market
Most people understand the term momentum when it comes to sports. If a team has gained momentum it means that there is an advantage that has shifted to them whether it be support from the crowd or some other intangible. Momentum in the Forex Market is not that much different. A distinct advantage has either gone to the bulls or bears depending on where the momentum is heading.
Momentum trading is probably one of the most popular of all of the trading strategies in Forex. One reason that it is popular is that it follows the current trend of the market. It does not involve trying to pick tops or bottoms. Traders go by a saying that “the trend is your friend” and that makes momentum trading a trend friendly strategy.
There are various tools which one can use and in determining momentum in a trade. Traders will use multiple periods of a Simple Moving Average. If there are multiple time frame SMAs on a chart which begin to fan-out, this could be a good indication of momentum taking place. Even though this setup may seem simple it can be highly effective.
Another indicator of momentum that is used by many Forex Traders is when the price approaches a previous high and proceeds to break through that high. In dealing with momentum traders one of the tricky thing for most traders is to know where to set your stop losses. A momentum trade could mean that there is additional volatility or greater swings. It is important for the trader not to get shaken out by that volatility.
Some of the other tools that are employed by Forex Traders when trying to discover momentum are: RSI Relative Strength Indicator . CCI Commodity Channel Index and Stochastics .
One strategy or indicator used by Forex Traders is the use of MACD/ Moving Average Convergence Divergence. Those that use the MACD as their momentum indicator use the position of the histogram to get that indicators signal.
One of the most challenging parts of momentum trading is knowing your exit points. One common mistake that momentum traders make that they tend to exit too soon after the momentum event has occurred. The discipline lies in keeping your stops but also being able to stay in the trade until an exit signal is generated.
Like many strategies and the Forex market momentum offers many benefits as well as its risks. Like with any trading strategy one should always test and practice before trading live.
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Trading Forex and Derivatives carries a high level of risk, including the risk of losing substantially more than your initial investment. Also, you do not own or have any rights to the underlying assets. The effect of leverage is that both gains and losses are magnified. You should only trade if you can afford to carry these risks. Trading Derivatives may not be suitable for all investors, so please ensure that you fully understand the risks involved, and seek independent advice if necessary
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