Understanding how to swing trade momentum stocks can dramatically increase trading profits for the trader that is willing to take some risk. Momentum trading is one of the riskiest and most aggressive ways to swing trade stocks.
HOWEVER with the high risk, comes high rewards, as stocks moving on momentum can make significant moves higher in very short periods of time. The key to successful momentum stock trading is to identify momentum stocks that are just making their moves or buy them when they start a pull back on profit taking.
Momentum stock trading works on the “greater fool” theory. This means though a stock may be overvalued and soaring based purely on momentum traders jumping in and buying the stock for a ride up, there will be a greater fool in the future that will pay a higher price than you paid for the momentum stock.
Naturally, this is an extremely risky way to trade stocks because when they reverse, it can happen very quickly, reversing weeks of gains in only a few days. Swing trading trading momentum stocks is all about riding the wave higher and locking in profits as the stocks lose momentum. That is the key, locking in profits with a trailing stop.
Some traders try to ride momentum stocks lower by shorting the stocks, as the stocks lose momentum and fall sharply. But shorting momentum stocks is difficult at best as they do not trade on fundamentals so in theory there is no limit to how high they may trade. So its best to either play them from the long side or just avoid them altogether.
How Momentum Stock Trading Works
Momentum stocks tend to be the stocks that everyone is talking about and everyone wants to own. They are concentrated in the Tech or Bio-Tech sector of the stock market, primarily on the Nasdaq.
They are almost always associated with some new technology or drug that traders and investors are excited about and its future prospects look unlimited. For example, recent momentum stocks have included Netflix (NASDAQ: NFLX) and Tesla Motor Corporation (NASDAQ: TSLA). Both of these companies are widely known and are involved in new technological developments that have huge, but unknown future potential for earnings.
The one thing you do not want to do is buy them when they are extended on the daily charts. This is a recipe to lose money quickly. What you want to do is wait for a pullback to support that lasts a few days and buy once the momentum returns.
I cannot stress enough how important it is to put in place a trailing stop-loss order in once you buy a momentum stock to protect your trading capital and get out of the trade, if the momentum falters. Because as fast as they go up, they fall even faster as traders dump the stock to take profits.
Assuming the stock continues higher, raise your trailing stop-loss order as the stock rises. At this point you have nothing to do except keep an eye on the stock and raise the stop as needed. If you have to take profits, sell only a portion. The reason being, you never know how high the stock can go. This is how you make BIG money in the stock market. Having stocks that double, triple or more in value and if you keep taking profits early you will never have those kinds of gains.
Once the momentum starts to fade and your stop gets hit, keep a close eye on the stock for another buying opportunity. BUT only after a pull back to a support area. Just be careful not to give back too much of your gains by trying to catch a falling knife, as when momentum stocks sell off it can be pretty dramatic.
How to Find Momentum Stocks
The easiest way to find momentum stocks is to go to www.finviz.com or any stock screener and scan for new 52 week highs. It is impossible for any momentum stock to not show up because by definition it will be making new highs almost everyday.
I wrote a post on a “Simple Swing Trading Strategy” that will show the scan and what to look for when it pulls back.
Of course the easiest way to trade momentum stocks is to just use a professional swing trading service like Microcap Millionaires and Jason Bond Picks and let them find the stocks for you.
If Penny Stocks are your thing, then you should definitely check out Microcap Millionaires.
You can read all the reviews here:
If you are looking to open a brokerage account or looking for a better one, I wrote some reviews of brokers I have used and currently using.
OptionsHouse Review (Currently Using)
Scottrade Review (Used when I first started)
Regardless of which Stock Picking Service you use or if even if you choose to go it alone, please download my free eBook: “The 7 Habits of Millionaire Traders”
– Robert Walsh