Momentum trading thrives on the principle that securities which have exhibited recent gains or losses are likely to continue their trajectory in the short to medium term. A critical aspect of successful momentum trading is the early identification of trends. Intraday historical stock data can help in trend identification as the lower frequency end-of-day data can obfuscate early trends.
Price Patterns and Breakouts:
Firstly, identifying the trends. Technical traders and analysts rely on chart patterns and statistical indicators to highlight and confirm the continuation or reversal of a prevailing trend.
Resistance or Support Level Breakouts: When a stock price breaches a well-defined resistance level, it indicates a potential upward move, while a breakout below a support level suggests a potential downward trend.
Although resistance and support levels can be calculated using statistics packages they are most commonly identified by visual reference to graphical charts.
Symmetrical Triangle Breakouts: A breakout from a symmetrical triangle pattern typically signifies the continuation of the dominant trend.
Head and Shoulders Breakouts: A breakout below the neckline of a head and shoulders pattern signals a potential bearish reversal.
Cup and Handle Breakouts: A breakout above the handle portion of a cup and handle pattern suggests a potential bullish trend.
Double Bottom or Double Top Breakouts: These patterns indicate potential trend reversals. A breakout above a double top or below a double bottom suggests a shift in trend direction.
Volume Confirmation: Validating Momentum with Trading Activity
An essential aspect of breakout confirmation is a upsurge in trading volume. An upsurge confirms the presence of significant momentum behind the price move. A low volume breakout is usually discounted and is often a false signal.
Typically, volume analysis is conducted at a very granular level using shorter timeframes than those of the breakout indicator. For instance, a trader generating signals using 5-minute stock data bars should employ volume analysis using 1-minute or even tick-level data to ensure sustained volume during the period.
Moving Averages: Filtering Noise
Moving averages smooth out trading patterns, filtering out noise and revealing key trend lines. A common setup involves generating a fast and slow moving average (with the slow MA approximately 5 times the fast MA) and using the MA crossovers as signals. For example, a buy signal is generated when the 30-minute moving average crosses above the 1-hour moving average. The spot price needs to be referenced for signal clarification (as it is the highest frequency data) to ensure that it remains above both moving averages for a buy signal.
Relative Strength Index (RSI): Gauging Intensity
The RSI, an indicator of momentum, measures the speed and magnitude of price movements. It represents the ratio of total gains to total losses over a specified period, usually 14 time units such as 5-minute or 15-minute bars. RSI values above 75 typically indicate an overbought condition, while values below 30 suggest an oversold condition.
Combining RSI with moving averages can enhance signal confirmation and prevent trading just before a trend reversal.
