Cryptocurrencies are notoriously volatile, and to excel in crypto trading would require in-depth strategic planning and technical analysis to secure consistent profits. Among all, momentum trading is used by traders and investors alike to buy an asset with an uptrend price and sell them when the asset’s price starts to lose its momentum.
Of course, trading comes with risks but momentum trading gives traders more control and fewer potential failure points with the help of indicators. In this article, you’ll learn momentum indicator meaning, some of the best momentum indicators, as well as the risks associated with momentum trading.
What is Momentum Trading?
Momentum trading is a trading style traders use to assess the strength of an asset’s current trend to buy an asset while the price is rising and sell it at an assumed peak price. The rationale behind momentum trading is if there is enough force driving a price move, then it will continue to move in the same direction for a moment.
With the concept of “buy low, sell high” in mind, traders tend to seek advantages from the volatile market for short-term gains through a consistent buy and sell action by following the trend signals.
For example, Bitcoin is hovering around $54,000 but on a general uptrend, trader A would place a buy order to catch the wave and take profit at an assumed price of $56,000 before the wave crashes. Trader A would then repeat the same momentum trading strategy in the hope to catch another wave for the same or other assets.
How Does Momentum Trading Work?
In trading, an asset tends to move in a specific direction until somETHing triggers the market to react differently. For example, when a cryptocurrency increases in price, it attracts more attention from both retail and institutional traders. As a result, it pushes the price even higher.
Sometimes the uptrend creates a fear of missing out (FOMO) effect, and the price continues to increase for much longer than it would actually do based on fundamental analysis. The uptrend may continue until a large number of sellers or whales believe that the price is overbought and doesn’t reflect the intrinsic value.
Hence, they open short positions en masse. When the trend reversal happens, momentum traders exit the market. However, if the new downtrend is gaining traction, momentum traders may enter the market again. But at this time, they go short. In this way, momentum traders can benefit from both trends with great success.
Momentum Indicator Meaning
For momentum traders, technical analysis is critical because it helps traders to define the market trend and refine the trading strategies. Momentum indicators are tools utilized by traders to get a better understanding of the speed or rate at which the price of an asset changes. Once you identify your ideal momentum indicator, it’s fairly easy to determine the market entry and exit points precisely.
Popular Momentum Indicators
Moving Averages
Moving averages (MAs) are the oldest and most common technical indicators out there. They are popular for decades to analyze all kinds of assets, and it’s all for good reasons. Part of the trend indicators group, MAs, cut the price action’s noise to smooth volatility that confuses traders and displays the general trend.
Traders use MA to calculate the average of a cryptocurrency price movement over a given period. For momentum traders, moving averages are important because they can show whETHer a trend continues its direction or tends to go sideways. It is visually apparent as the MAs follow the price action.
Traders would generally use two MAs with different periods. When the shorter MA crosses the longer MA, then the existing trend may be reversing, and momentum traders would be interested in closing positions.
The relative strength index (RSI) is one of the most popular oscillators, which acts as a momentum indicator. It calculates the size and magnitude of the latest price changes.
Relative Strength Index
The RSI line is plotted on a separated chart below the price action and fluctuates between 0 and 100. If the RSI goes below zero, it shows an oversold level, suggesting that the current downtrend might reverse.
On the flip side, if the RSI goes above 70, the market enters an overbought level, meaning that the current uptrend is losing momentum and might gradually turn into a downtrend or move horizontally. Thus, momentum traders should be on alert whenever the RSI is above 70 or below 30, as the bullish or bearish sentiment is reaching oversaturation, and the trend is changing.
MACD
Moving Average Convergence Divergence (MACD) is a bit more sophisticated. It behaves both like momentum and trend-following momentum indicators. The MACD merges two exponential moving averages (EMAs), and its result is calculated by subtracting the 26-period EMA from the 12-period EMA.
However, the two lines displayed on the MACD chart are not the two EMAs used by the indicator. Instead, one of the lines is the MACD line, and another one is the signal line, which can determine changes in price momentum and provide buy or sell signals. There is also a histogram, which represents the difference between the MACD line and the signal line.
When the two lines depart from each other, momentum is considered more substantial, and traders can rest assured that the current trend would continue.
Benefits and Limitations of Momentum Trading
This trading style is suitable for beginners because of its simplicity. Above all, momentum trading can be profitable if you catch the momentum at the right time. Besides, it works well in any timeframe and thus, suitable for both day traders and swing traders.
On the flip side, momentum trading can be risky as it purely relies on market information and trends. Traders can be taken by surprise by the unexpected trend reversals. Depending on the securities you’ve chosen, momentum trading is not the best fit for leveraged securities due to the complex underlying futures markets.
Also, prices can fluctuate up and down without any prior signals due to unexpected events or large trades from whales.
Closing Thoughts
All in all, having learnt momentum indicator meaning will prove fruitful for any aspiring trader, given that momentum trading is one of those universal strategies that are suitable for both beginners and advanced. It works well in any timeframe higher than H30 and can thus be implemented by both day traders and swing traders.
Another major benefit is that momentum trading is backed by a lot of technical indicators that were designed precisely to determine the strength of a trend. But as always, momentum indicators should be used in conjunction with other indicators and tools.
