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A Day in the Life of the Momentum Trader

A good way to illustrate momentum trading is to look at a typical day of a momentum trader: 

He gets up an hour before the market opens, switches on his computer, goes online and immediately logs into one of the popular trading chat rooms or message boards.

When looking at these boards, our hero focuses on stocks that are generating a significant amount of buzz. He looks at stocks that are the focus of trading alerts based on earnings or analyst recommendations. These are stocks rumored to be in play, and they are anticipated to provide the most significant price movements on high volume for that trading day.

While surfing the web, he will also turn on CNBC and listen for mentions of companies releasing news or positioned to undergo significant movement.

He eyes the morning equity options pages to find stocks with significant volume increases in calls. Any increase in calls written indicates that a price increase or decrease above or below the option premium is expected.

Once the market opens, he watches his initial list of stocks in relation to the rest of the market: Are his stocks going up when the market goes down? Are they significantly increasing in price in relation to the rest of the market? Are they behaving consistently with his expectations based on his pre-market assessment?

He will then narrow his watch list to include only the strongest stocks: those increasing more rapidly on higher volume than the rest of the market, stocks trading contrary to the market and stocks with movements clearly propelled by external factors.

Analyzing the Charts

Next, a momentum trader will analyze the list of stocks he has chosen to focus on by examining their charts. The primary technical indicator of interest is the momentum indicator - the accumulated net change of a stock's closing/ending price over a series of defined time periods. The momentum line is plotted as a tandem line to the price chart, and it displays a zero axis, with positive values indicating a sustained upward movement and negative values indicating a potentially sustained downward movement.

That upward or downward momentum indicator often immediately portrays a breakout for the stock, which means that even a period or two of sustained momentum will propel that stock in the direction of the breakout. While watching the momentum chart, he has his Level 2 screen up, looking for evidence of a push, where bids start to line up (indicated by the presence of market-maker limit orders) and offers start to disappear.

When the trader believes he has identified a breakout, he does not necessarily need to jump immediately into the stock. He is not generally worried about missing the first one or two breakout ticks, but he has his hand on the buy trigger (or sell trigger in the case of a short sale, but a short sale must be done on an uptick) for one of the next momentum periods. And he is generally not too concerned about hitting the bid either, as he will have an easier time getting in at the market price. Then he places a market order.

Momentum Trader: In Position

Once he has entered into his position, the white-knuckle ride and nail-biting begins. Will the stock continue to move strongly in the direction of his momentum line? Or will it immediately change course, proving the momentum chart wrong and perhaps pointing to a trap set by the market maker? Or will the breakout fizzle quickly, providing some limited upside but not enough profit to make the trade worthwhile?

Whether the momentum fizzles almost immediately or continues to build, the trader remains glued to his screen. He is looking for a saturation point, where orders start piling up on the offer and bidding slows or thins at the market price a few levels back on the Level 2 screen. The saturation point does not mean an immediate end to the momentum, but it may signal that the top is near. So the trader sells his position (or covers his position in the case of a short sale) and takes his profits to pack it in for the day or to move on to the next stock on his list.