Momentum Trading: How to Find and Trade Stocks with Strong Trends

Momentum trading is built on a simple observation: stocks that are going up tend to keep going up, and stocks that are going down tend to keep going down — at least for a while.

Instead of trying to buy low and sell high, momentum traders buy high and sell higher. They ride trends while they last and exit when the momentum fades.

This guide covers how to identify momentum, the best indicators to use, entry and exit strategies, and how to manage the significant risks involved.

What Is Momentum Trading?

Momentum trading seeks to profit from the continuation of existing price trends.

The core principle: Stocks in motion tend to stay in motion.

Why it works:

• Institutional buying/selling takes time to complete
• News and earnings take time to be fully priced in
• Investor psychology creates trend persistence
• FOMO and fear amplify moves

The physics analogy: Like a rolling ball, stocks with momentum require force (selling pressure) to slow down and reverse. Until that force appears, the trend continues.

Momentum vs. Other Strategies

Key difference: Momentum traders want acceleration and speed. Trend followers want direction and persistence. Momentum is more aggressive with shorter holding periods.

Types of Momentum

Price Momentum

The most direct form — stocks making strong price moves.

Measured by:

• Percentage gains over time periods (1 week, 1 month, 3 months)
• Rate of change (ROC)
• New highs/lows
• Distance from moving averages

Relative Momentum

How a stock performs compared to others.

Measured by:

• Relative strength vs. S&P 500
• Relative strength vs. sector
• Percentile ranking among peers
• Outperformance ratios

Why it matters: A stock up 5% when the market is down 2% shows stronger momentum than a stock up 7% when the market is up 10%.

Earnings Momentum

Acceleration in fundamental performance.

Measured by:

• Earnings surprises (beat estimates)
• Estimate revisions (analysts raising numbers)
• Revenue acceleration
• Margin expansion

Connection to price: Earnings momentum often precedes or confirms price momentum.

Key Momentum Indicators

1. Relative Strength Index (RSI)

Measures speed and magnitude of price changes.

Calculation: Compares average gains to average losses over a period (typically 14 days).

Range: 0 to 100

Momentum use:

• RSI above 50 and rising = bullish momentum
• RSI above 70 = very strong (may continue or exhaust)
• Look for RSI to confirm price moves

2. MACD (Moving Average Convergence Divergence)

Shows trend direction and momentum shifts.

Components:

• MACD line = 12-day EMA minus 26-day EMA
• Signal line = 9-day EMA of MACD line
• Histogram = Difference between MACD and signal

Momentum signals:

• MACD above signal line = bullish momentum
• MACD below signal line = bearish momentum
• Histogram expanding = momentum accelerating
• Histogram contracting = momentum fading

3. Rate of Change (ROC)

Measures percentage price change over a period.

Calculation: ((Current Price - Price n periods ago) / Price n periods ago) × 100

Example: Stock at $110, was $100 ten days ago → ROC = 10%

Use:

• Positive and rising ROC = accelerating upside momentum
• Negative and falling ROC = accelerating downside momentum
• ROC crossing zero = potential trend change

4. Moving Averages

Smooth price data to identify trend direction.

Common momentum setups:

• Price above 20-day MA = short-term bullish
• 20-day above 50-day = intermediate bullish
• All MAs stacked (20 > 50 > 200) = strong trend

Moving average slope:

• Steep upward slope = strong momentum
• Flattening slope = momentum fading
• Turning down = momentum reversing

5. Relative Strength (RS)

Compares a stock's performance to a benchmark.

Calculation: Stock Price / Benchmark Price

Interpretation:

• Rising RS line = outperforming benchmark
• Falling RS line = underperforming benchmark
• RS at new high = leadership

Best momentum candidates: Stocks with rising RS making new highs.

6. Average Directional Index (ADX)

Measures trend strength (not direction).

Momentum use: Look for ADX above 25-30 to confirm tradeable trends.

Finding Momentum Stocks

Screening Criteria

Price momentum screens:

• Up 20%+ in past month
• Making 52-week high
• Trading above all major moving averages
• Up 5 of last 7 days
• Gap up with volume confirmation

Relative momentum screens:

• Outperforming S&P 500 by 10%+ over 3 months
• Sector leader (top 10% of sector)
• Breaking out relative to peers

Volume confirmation:

• Volume 50%+ above average on up days
• Accumulation pattern (up volume > down volume)

Daily Momentum Scan

Run this scan each morning or evening:

code-highlight
Criteria:
- Price > 200-day MA (uptrend)
- Price > 50-day MA (intermediate uptrend)
- RSI(14) > 50 (momentum positive)
- Volume > 1.5x average (interest)
- Up 3%+ today OR at 52-week high

Sector Momentum

Strong sectors produce the best momentum stocks.

Process:

1. Identify strongest sectors (relative strength ranking)
2. Find leaders within strong sectors
3. These have "double momentum" — sector tailwind plus individual strength

Entry Strategies

1. Breakout Entry

Buy when price breaks above resistance with volume.

Setup:

• Stock consolidating below resistance
• Volume drying up (calm before storm)
• Strong sector, strong fundamentals

Trigger:

• Price breaks above resistance
• Volume surges (1.5x+ average)
• No immediate overhead supply

Stop loss: Below the breakout level or recent swing low

2. Pullback Entry

Buy a temporary dip in an uptrend.

Setup:

• Stock in established uptrend
• Pullback to support (moving average, trendline)
• Momentum indicators still positive

Trigger:

• Bounce off support
• Bullish candle pattern
• Volume increase on bounce

Stop loss: Below the support level

3. Continuation Entry

Buy when momentum resumes after a pause.

Setup:

• Strong initial move
• Sideways consolidation (flag, pennant)
• Decreasing volume during consolidation

Trigger:

• Break above consolidation range
• Volume expansion
• Momentum indicators turn up

Stop loss: Below consolidation low

4. Relative Strength Breakout

Buy when RS line breaks to new high.

Setup:

• Stock outperforming market
• RS line approaching prior high
• Price consolidating or setting up

Trigger:

• RS line breaks to new high
• Price confirms with breakout
• Sector also showing strength

Stop loss: Below recent swing low, or if RS line breaks down

Exit Strategies

Knowing when to exit is as important as knowing when to enter.

Exit Signal 1: Momentum Fading

Signs:

• RSI divergence (price higher, RSI lower)
• MACD histogram shrinking
• Smaller daily gains
• Volume declining on advances

Action: Tighten stops, consider partial profits

Exit Signal 2: Moving Average Break

Trigger: Price closes below key moving average (20-day or 50-day depending on timeframe)

Action: Exit or reduce position

Exit Signal 3: Support Break

Trigger: Price breaks below prior swing low or trendline

Action: Exit immediately — trend may be reversing

Exit Signal 4: Target Reached

Method: Set profit targets based on:

• Prior resistance levels
• Measured move (height of base added to breakout)
• Risk/reward ratio (3:1 target)

Action: Take full or partial profits

Exit Signal 5: Time Stop

Logic: If momentum hasn't continued within expected timeframe, the thesis may be wrong.

Example: If no follow-through within 5 days of breakout, reassess.

Trailing Stops

Let winners run while protecting profits.

Methods:

• ATR-based: 2x ATR below price
• Moving average: Below 10-day or 20-day MA
• Percentage: 7-10% below peak
• Swing low: Below most recent higher low

Risk Management for Momentum Trading

Momentum trading is inherently risky. Fast movers can reverse fast.

Position Sizing

Rule: Risk no more than 1-2% of account per trade.

Calculation:

code-highlight
Position Size = (Account × Risk %) / (Entry - Stop Loss)

Example:
Account: $50,000
Risk: 1% ($500)
Entry: $50
Stop: $47
Risk per share: $3

Position size: $500 / $3 = 166 shares

Stop Loss Rules

Requirements:

• Every trade needs a stop loss
• Set before entering
• Based on technical levels, not arbitrary percentages
• Never move stops further away

Typical stops:

• Below breakout level
• Below recent swing low
• Below key moving average
• 1-2 ATR below entry

Managing Winners

Options:

1. Full exit at target: Simple, no regrets
2. Scale out: Sell half at 1:1 R/R, let rest run
3. Trail stop: Move stop up as price advances
4. Hold core position: Take profits but keep some exposure

Maximum Daily/Weekly Loss

Circuit breaker: Stop trading if you lose 3-5% of account in a day or 10% in a week.

Why: Prevents catastrophic losses and emotional trading.

Momentum Trading Styles

Day Trading Momentum

Timeframe: Minutes to hours

Focus:

• Opening range breakouts
• Gap-and-go setups
• High relative volume
• News-driven moves

Characteristics:

• Many trades per day
• Small gains compound
• Requires constant attention
• Same-day exit (no overnight risk)

Swing Trading Momentum

Timeframe: Days to weeks

Focus:

• Multi-day breakouts
• Sector rotation
• Earnings momentum
• Technical patterns

Characteristics:

• 2-10 trades per month
• Larger moves per trade
• Hold overnight
• Moderate time commitment

Position Trading Momentum

Timeframe: Weeks to months

Focus:

• Long-term relative strength
• Sector and industry trends
• Fundamental momentum
• Major breakouts

Characteristics:

• Few trades per year
• Ride extended trends
• Wider stops
• Less screen time

Common Momentum Patterns

1. Breakout and Retest

code-highlight
Price:
        ____/
       /
______/
      ↑
   Breakout

Pattern: Price breaks resistance, pulls back to test it as support, then continues higher.

Entry: On successful retest (bounce off prior resistance)

2. Flag/Pennant

code-highlight
Price:
    ___
   /   \___
  /        \___  <- Flag
 /             ↗
/
↑
Strong move (pole)

Pattern: Strong move, tight consolidation, continuation in original direction.

Entry: Break above flag resistance

3. Cup and Handle

code-highlight
Price:
\        /\
 \      /  \___/
  \    /       ↗
   \__/

 Cup     Handle

Pattern: Rounded bottom, small pullback (handle), breakout.

Entry: Break above handle resistance

4. Momentum Thrust

code-highlight
Price:
       |
       |
    ___|
___/
↑
Volume spike

Pattern: Explosive move on huge volume — often starts new trend.

Entry: Pullback after initial thrust, or immediate if stop is nearby

Sector Momentum Rotation

The Strategy

Rotate into the strongest sectors, out of the weakest.

Process:

1. Rank sectors by relative strength (1 week, 1 month, 3 months)
2. Identify top 2-3 sectors
3. Find leading stocks within those sectors
4. Exit when sector momentum fades

Sector Rotation Cycle

Different sectors lead at different points in the economic cycle:

Momentum application: Be in sectors with rising relative strength, regardless of economic theory.

When Momentum Fails

Reversals

What happens: Trend reverses sharply, often gapping against you.

Causes:

• Unexpected news (earnings miss, FDA rejection)
• Sector rotation
• Market correction
• Profit-taking after extended run

Defense: Always use stops, size positions appropriately.

Choppy Markets

What happens: Breakouts fail, trends don't develop.

Signs:

• Failed breakouts increase
• Whipsaws common
• ADX below 20
• No sector leadership

Response: Reduce position size, wait for clarity.

Crowded Trades

What happens: Everyone piles into the same momentum stocks.

Signs:

• Stocks appear on every "top performers" list
• Social media hype
• Extremely high RSI (80+)
• Parabolic price moves

Risk: Violent reversals when buyers are exhausted.

Momentum Trading Mistakes

Mistake 1: Chasing Extended Moves

Buying after a stock is already up 50%+ often leads to buying the top.

Fix: Wait for pullback or find earlier-stage setups.

Mistake 2: Ignoring Stops

Momentum reversals are fast and severe.

Fix: Use stops religiously. No exceptions.

Mistake 3: Oversizing

One big loss can wipe out many small wins.

Fix: Keep position sizes consistent and small.

Mistake 4: Trading Against the Market

Individual stock momentum struggles when the market is falling.

Fix: Consider market direction; reduce exposure in downtrends.

Mistake 5: Holding Through Catalysts

Earnings and events can gap stocks 20%+ against you.

Fix: Exit or reduce before binary events.

Mistake 6: Not Tracking Performance

Without data, you don't know what's working.

Fix: Keep a trading journal. Review regularly.

Momentum Trading Checklist

Pre-Trade

• Stock in uptrend (above key MAs)?
• Relative strength positive vs. market?
• Sector showing strength?
• Volume confirming the move?
• Clear entry trigger (breakout, pullback bounce)?
• Stop loss level defined?
• Position size appropriate (1-2% risk)?
• No earnings or major events imminent?

Entry

• Trigger confirmed?
• Volume supporting the move?
• Risk/reward at least 2:1?
• Stop order placed?

Management

• Daily review of position?
• Momentum still intact?
• Move stop to breakeven after 1R profit?
• Trail stop as trend progresses?

Exit

• Momentum fading?
• Stop hit?
• Target reached?
• Time stop triggered?
• Record trade in journal?

Quick Reference: Momentum Trading Cheat Sheet

Best Conditions for Momentum

Entry Triggers

Exit Signals

Frequently Asked Questions

What is momentum trading?

Momentum trading is a strategy that buys stocks showing strong upward price trends and sells (or shorts) stocks in downtrends. The core belief is that stocks moving strongly in one direction tend to continue moving that way. Traders ride the trend until momentum fades.

What indicators are best for momentum trading?

Key momentum indicators include: RSI (Relative Strength Index) for overbought/oversold, MACD for trend direction and crossovers, Rate of Change (ROC) for price velocity, moving averages for trend confirmation, and Relative Strength vs market/sector for comparative performance.

How long do momentum traders hold positions?

Holding periods vary by style: day traders hold minutes to hours, swing traders hold days to weeks, and position traders hold weeks to months. Most momentum trades last 2-10 days as that's when trends are strongest. Exit when momentum fades, not on a calendar.

What is the difference between momentum and trend trading?

Momentum focuses on the speed and acceleration of price moves, often catching explosive short-term moves. Trend trading focuses on the overall direction over longer periods. Momentum traders want fast moves now; trend traders want sustained direction. Many strategies combine both.

Is momentum trading risky?

Yes, momentum trading carries significant risk. Fast-moving stocks can reverse quickly, causing large losses. Risk management is essential: use stop losses, size positions appropriately, avoid chasing extended moves, and accept that many momentum trades will fail. The winners must outpace the losers.

Related Articles

Build your momentum trading skills:

• RSI Indicator Guide — Master this key momentum indicator
• Moving Averages Explained — Trend confirmation techniques
• Volume Analysis Guide — Confirm momentum with volume
• Trading Risk Management — Essential protection for momentum traders
• How to Build a Watchlist — Find momentum candidates