Is Momentum Trading Draining Your Account?

I have seen and heard from many new traders who buy right at or near the high of the day or sell at or near the low of the day and then can’t believe the outcome. Either their strategy rules or their emotions had them entering the market at the worst possible price, which is obviously not ideal. The focus of this piece is to understand why this happens and how we can, not only correct, but also start to profit.

As I mentioned above, there are really two reasons someone would buy at or near the high of the day. One is because some good news came out, the market rallied to a new high and traders who focus on fundamental information bought or sold because they thought the market was going higher. The other is because they are momentum traders. If you have been trading for a while, you have probably noticed that most momentum style trades fail, and there is a reason for this.

Live Trading Session: 2/8/18: British Pound Futures

Chart

Let’s use a recent trading opportunity found in our live trading room, the Extended Learning Track (XLT), in the Pound Futures market. Notice the supply level in the upper left part of the chart. Our strategy rules tell us Banks are big sellers at that level. Notice when price rallies strong back up to the supply level. This happens because novice buyers see price shooting higher (momentum) and they end up buying after a big rally in price. What they ignore is that they are also buying at a price level where Banks are selling. When this happens, the outcome of price is fairly certain.

The Bank (or smart trader) wants you to think that price will break out and run higher so that you will buy into that momentum. The game is to buy low and sell high, which means finding someone that will buy from you at much higher prices. The reason price declined so fast and far from supply is because buying that momentum was the real sucker bet. There were few buyers left and plenty of Bank supply which means a strong decline in price and a profit for us (those on the other side of the momentum trade).

The next time you are thinking of buying into momentum or shorting a break down in price, make sure you look to the left and see what price is moving into. If there is fresh supply or demand at that level, you are likely better off taking the opposite position of the move. Always ask yourself if what you’re doing is in line with how you make money buying and selling anything.

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