Five Momentum Trading Techniques to Properly Ride Market Waves
- Momentum of Relative Strength
One of the momentum trading techniques that aids in locating stocks that have been beating the market or benchmark is relative strength momentum.
The financial market’s strongest and weakest securities or asset classes may be found using the RS Indicator. Strong or weak RS over a period of time tends to persist in stocks. Both local and foreign equities, stock indexes, fixed-income indexes, currencies, commodities, and other asset classes can all be subject to RS research. We have plotted the RS line (blue line) against the Nifty 50 for the last 50 periods in the Reliance India Ltd. daily chart above.
The stock is outperforming the index when the RS line goes above zero, and it is underperforming the index when it crosses below zero. As can be seen from the preceding chart, the stock entered a bearish phase on March 11th, when the RS line crossed the 0 line. This indicates that when prices decline, the stock is becoming weaker and lagging the index.
- Momentum Absolute
Absolute momentum is a method that evaluates a security’s price based on its historical performance. When a trader employs this approach, they should buy when the momentum is positive and sell when it is negative.
If a stock’s 12-month momentum is notably positive, for example, a momentum trader may purchase additional shares of the stock. In contrast, a trader would short-sell shares if the 12-month momentum was negative.
- Momentum Across Assets
Additionally, traders may generate large, positive monthly alphas by developing cross-asset momentum trading techniques with passive exposures to the bond and equities markets.
The Sharpe ratio of a diversified cross-asset momentum portfolio is around 70% greater than that of a buy-and-hold portfolio with a comparable level of diversification, and it is 45% higher than that of a time series momentum portfolio with the same level of diversification.
Using this momentum trading technique, the traders Decide on a timeframe (such as three, six, or twelve months) to assess momentum. Determine each asset’s overall return throughout the lookback period, then rank the assets according to momentum, usually giving special attention to those with the highest positive momentum.
- Strategy for Sector Momentum
A sector momentum approach involves identifying and investing in market sectors that are now performing strongly in the hopes that this momentum will continue. One momentum trading strategy that capitalizes on the successful sectors’ tendency to continue outperforming over the short to medium term is this one.
Traders can compile a list of industries to keep an eye on. Often mentioned examples include the industrial sector, consumer discretionary, energy, healthcare, technology, and finance.
Moving funds from one industry sector to another in anticipation of various business cycle stages in order to outperform the market is known as sector rotation, and it is a top-down investment approach.
Similar to the tactical asset allocation method, money flows in accordance with the anticipated performance of sectors rather than changing asset classes and liquidity. Because a certain collection of industries dominates a given market cycle and the market moves in fairly predictable cycles, the sector rotation forecast is tenable.
- Breakout Strategy for Price Momentum Trading
Shares that go over their support or resistance level are known as breakout stocks. Breakouts, a fundamental idea in technical analysis, can signal that a stock is poised for a significant rise.
A stock will thus often continue to rise steadily once it breaks over its resistance level. It may go on a bear run if it breaks over its support level.
If a stock hits support and resistance levels several times, they are sometimes seen as “stronger.” Stocks that breach these “stronger” levels typically exhibit notable movements in response.
Assets that surpass support and resistance levels are not limited to stocks. any kind of financial asset, including cryptocurrency, commodities, and foreign exchange.