Newton’s first law states that an object in motion continues to move by inertia unless an external force acts upon it. The financial markets behave the same way. Trading may start with a specific price trajectory, which will be maintained for some time. This is called market momentum. It reflects the volatility of the exchange rate, sets the trend, and demonstrates the mood of traders. Bullish or bearish moves mean strong momentum, and reversals mean weakening. Traders use these reactions to make money. This strategy is called momentum trading. We will tell you how it works in the cryptocurrency market.
What is momentum trading?
This is a strategy in which traders take advantage of short-term price fluctuations. They buy assets when they sense an emerging uptrend and sell at the highest price before a reversal occurs. The mantra of momentum traders is “Take high, give high.” The strategy is more often used for intraday transactions and scalping. However, given the tool’s effectiveness, loopring price prediction long-term traders also do not neglect it.
This proves the success of the Richard Driehaus Foundation. Other famous entrepreneurs (Warren Buffett, Benjamin Graham, Peter Lin) have also used this strategy. However, Richard Driehaus has considered the father of momentum investing. His approach focused on small and micro-cap stocks up to $500 million and mid-cap stocks up to $3 billion. Richard Driehaus invested in securities with a strong upside move and built on that momentum for as long as possible. As a result of the strategy, his mid-cap fund grew 22.2% in 1999, and his investment in low-total-cap assets rose 196.6%.
Cryptocurrency impulse trading
According to a study by the University of Sussex in the UK, the strategy works well on digital coins as they have no intrinsic value and are prone to speculative bubbles.
There are 2 types of momentum traders:
- Absolute – consider only one asset (for example, Ethereum ).
- Relative – analyze and compare the price movement of various assets (for example, Ethereum and Binance Coin ), and then make a decision.
Every momentum trader needs to understand that trading success depends on 3 factors:
- Volatility. The strength of a trader lies in the ability to recognize and exploit short-term price movements.
- Volume. A trader can determine the price movement of an asset on a 24-hour trading chart. The larger the volume, the higher the supply and demand for cryptocurrency. High demand drives prices up. Conversely, a downward price movement demonstrates low demand for the asset. However, traders should know that whales can manipulate the market by placing huge buy and sell orders. This will either cause the price to rise or fall.
- Period. One way to make a profit is by comparing time frames. For momentum to be significant, an uptrend must be applied to multiple periods – 15 minutes, 30 minutes, 1 hour, 4 hours, and 24 hours. If an upward move is only visible in a one-time frame, it may be part of an ongoing downtrend.
Principles of Risk Management in Momentum Trading
Despite the profitability, the strategy is associated with a high probability of monetary losses. cartesi price prediction Therefore, risk management is an important skill a crypto trader should have. There are certain principles to follow with momentum trading. These include:
- The choice of cryptocurrencies for investment.
- Risk control when opening and closing a transaction.
- Getting the perfect entry point.
- Understanding position management.
Selection of the best assets
Liquid cryptocurrencies are best suited for momentum trading. Traders should avoid leveraged assets as their price movements do not accurately reflect the value of the underlying coin. It is also necessary to keep an eye on the news (adding new features or partnership agreements) that can cause a sudden jump in the price of the cryptocurrency.
Risk control when opening and closing a deal
When using momentum trading, there may be nuances that a trader needs to be aware of. They carry risks and can lead to strategy failure:
- Entry into the trade too early, before the momentum is confirmed.
- Exiting the operation too late.
- Failure to follow the market. It is possible to miss a change in momentum caused by a major news event or another factor.
- Inability to control emotions. This can keep the trader from exiting a bad trade as he assumes the momentum will work in his favour.
Ideal Entry Point
The momentum trader must be vigilant. The best trades are triggered by news events that trigger a sudden uptrend. Therefore, it is important that the trader gets this information and secures an early position. One working way to keep track of the latest data is through the top crypto sites that post a lot of the latest news. An ideal entry point offers high rewards with minimal risk. Conversely, downtrends are dangerous and should be avoided.
Position Management
Attentive momentum traders know how long they want to hold an open trade. The longer this period, the higher the risk. Momentum strategies work well in day trading. Speculators often hold large positions to make up for the short trading period. On the other hand, traders who keep trades open longer can reduce trade sizes to balance the risk.
How to Determine Momentum in Cryptocurrency Trading
For this, technical indicators are used. They measure the rate of change in the value of a crypto asset by comparing the current value with previous periods (in minutes, hours or days). The greater the difference between the courses, the faster the movement and the greater the momentum.
Relative Strength Index
This indicator is used to analyze recent exchange rate changes. It allows you to determine whether a crypto asset is overbought or oversold. The RSI moves from 0 to 100. The overbought and oversold points are set at 70 and 30, respectively. An RSI above 70 indicates that the crypto coin is overbought and signals a sell.
This indicator characterizes:
- High demand.
- Bulk purchases.
- Possible increase in bearish momentum.
The Relative Strength Index below 30 is oversold and a buy signal. The indicator characterizes:
- High demand.
- Probable increase in bullish momentum.
Stochastic Oscillator
This indicator also determines the degree of overbought or oversold digital coin. Unlike RSI, the oscillator compares the closing price of a crypto asset with its range from high to low over a specific period. This index also ranges from 0 to 100. Here, 80 is the overbought area, and 20 is the oversold area.
An oscillator value above 80 characterizes:
- High demand.
- Bulk purchases.
- Possible increase in bearish momentum.
A reading below 20 indicates:
- Mass sale.
- Probable increase in bullish momentum.
Moving Average and Moving Average Convergence/Divergence
MA calculates the average closing price of an asset for a specified number of days elapsed (for example, 20, 50, or 200). The indicator determines the direction of the trend. Momentum traders rely on short-moving averages (eg 20-day).
When the MA rises, it indicates an uptrend. If it goes down, it indicates a downward trend. In addition, the moving average allows you to detect intersections (crossovers) of indicators (for example, 50-day MA and 200-day).
Crossovers often help traders spot momentum. Bullish indicates an uptrend. This happens when the short-term moving average crosses the long-term line. In contrast, a bearish crossover signifies downward momentum. In this case, the short-term moving average crosses below the long-term one.
MACD is an indicator derived from the MA. It demonstrates the relationship between two moving averages of a crypto coin. It is usually calculated as the difference between a 12-period exponential moving average (EMA) and a 26-period exponential moving average. To use the MACD effectively, a trader must recognize and understand the MACD and signal lines on the chart.
The first is derived from the difference between the 12-period EMA and the 26-period EMA. The second is a 9-period EMA chart. If the MACD line crosses above the signal line, this indicates a bullish trend. If it is lower, it is bearish.
Remember that MA and MACD are known as lagging indicators as they follow the course. They provide information based on previous trends.
Final Thoughts
Momentum trading allows you to determine and use the moment for transactions. With the help of the strategy, crypto traders can quickly make profits. However, this requires a deep understanding of technical analysis and indicators. If misused, speculators can just as quickly lose their investment. Here, the golden trading rules apply: you can risk what you are ready to lose, and you should always do your own market research.
