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TradingDay.com > Technical Analysis Tutorial

T e c h n i c a l   A n a l y s i s   T u t o r i a l
by Alan Farley

Momentum Cycles

Neophytes quickly fall under the spell of fast moving markets. However, trading momentum is far more difficult than most participants admit. When the emotional crowd ignites sharp price movement, greed clouds risk awareness. The inexperienced trader reacts foolishly and chases positions just behind the big volume, where odds of a reversal quickly increase.

Prices rarely move in a straight line. As shocks destabilize a market, counter force emerges to restrain price back toward its stable state. An inevitable backward reaction follows each forward impulse. Burning the fuel of the crowd's money, markets seek equilibrium before proceeding with the next price thrust.

Unskilled traders fail to consider this cycle when entering momentum trades. They blindly execute positions with a common and dangerous strategy: market entries on accelerating thrusts. Lacking trailing stops and effective risk management, both good and bad positions bleed money as sharp countertrends destroy profits. As these inevitable reactions wind down, losses escalate as blind fear chooses the exact turning point to finally get out.

Consider both action and reaction when developing effective momentum trades. This demands complex planning and detached execution. One successful strategy requires trading opposite to natural bias: entries on counter trend reactions and exits on accelerating thrusts. This aligns positions to the underlying trend but against the current crowd emotion. Entries into accelerating momentum can also work when tight stops are placed and the trader exits into further acceleration. This eliminates risk associated with the inevitable pullback.

Choosing the wrong action-reaction trigger produces frustrating results. Every trader knows the pain of executing a low risk entry, riding a profitable trend, then losing everything on a subsequent reaction. Avoid this experience using clearly defined tactics to minimize emotional momentum trading. Supplement this discipline with multi-trend technical analysis and cross-verification to identify profitable swing-points and locate natural escape routes.

Riding the Wave: Markets inhale and exhale as dynamic trends evolve. Reaction follows impulse as momentum seeks stability in preparation for new price change. Smart traders read this continuous cycle through the wave motion in bar charts.
 


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