Momentum trading is a type of stock trading strategy that involves buying stocks that have recently experienced significant price increases and selling stocks that have recently experienced significant price decreases. The theory behind momentum trading is that stocks that have been performing well in the recent past are likely to continue performing well in the near future.

In momentum trading, traders use technical analysis to identify stocks with strong upward momentum and then buy those stocks with the expectation that their price will continue to rise. Similarly, traders use technical analysis to identify stocks with strong downward momentum and then sell those stocks with the expectation that their price will continue to fall.

Momentum traders typically hold their positions for a relatively short period of time, ranging from days to weeks. They may also use stop-loss orders to limit their downside risk if the momentum of a stock suddenly changes direction.

While momentum trading can be profitable in the short term, it is also a high-risk strategy that can result in significant losses if the momentum of a stock suddenly changes direction. As with any trading strategy, it is important for traders to carefully manage their risk and to have a well-defined trading plan.

Momentum trading works by taking advantage of strong price movements in the market. The idea is simple: traders buy assets that are rising and sell assets that are falling, expecting the trend to continue. Instead of focusing on an asset’s fundamental value, momentum traders rely on technical indicators like moving averages, the Relative Strength Index (RSI), or volume patterns to spot entry and exit points. The strategy assumes that once a trend gains speed, it often carries on for some time due to market psychology and herd behaviour. However, momentum trading requires quick decision-making, as sudden reversals can lead to losses. Successful momentum traders often use stop-loss orders to manage risk and protect their capital.