InvestorQ : Can you tell me tips on how to stay on the ride side of momentum while trading?
Archita Jajjoo made post

Can you tell me tips on how to stay on the ride side of momentum while trading?

Dia Deshpande answered.
3 years ago

There are different types of trends. There is a long term trend and there is short term momentum. Don’t confuse these two things. For example, a bull market in equities may last for a period of 3-4 years. But within this broad trend there will be a plethora of sub-trends that could be either in the same direction of momentum or on the opposite side. The idea of trading is to ensure that you are able to read these sub-trends and trade accordingly.

Focus on the short term trend first. While the short term trend creates the momentum and helps you to trade, it is the longer term trend that will be your guide. For example, if we are in the midst of a long-term secular bull market then buying on dips makes a lot more sense. Similarly, if you are in a long term bear market then selling on every bounce makes a lot more sense. Your momentum trade are ultimately driven by the larger trend.

Market is a great master but it is awful when you try to outsmart it. That is the basic humility that you need to cultivate. Remember, the stock market is the king and you as a trader are a student of the market. Don’t try to outguess or outsmart the market. The market, after all, represents the collective wisdom and follies of millions of investors. Good, bad or ugly; it represents the market reality and there is not running away from that. A good trader always reads momentum as a student of the market, rather than outguessing it.

We come to a real challenge. There is so much noise in the market and how do you distinguish the trend from the noise. Then look so similar. Learn to distinguish the trend from the noise. Noise can be extremely short term ranging up to 1-5 days. This noise is typically created by specific trades, news flows, block deals etc. Noise is not trend and you cannot really trade based on noise. That is because noise is just too random to be of any meaningful use and too unpredictable. The challenge is to remove the noise and delineate the trend to trade.

More than the trend; focus on the triggers for a trend. That is when you can positions yourself at the right place at the right time. It is very important to understand the triggers that create trend shifts. What shifts the trend from a negative trend to a positive trend? There could be a variety of triggers ranging from a reformist budget, positive news flows, high-level reforms announcements by the government, positive IIP and GDP data, low inflation etc. These triggers normally act as lead indicators for trend shifts.

There are two aspects to momentum. It is not just about direction alone. You also need to gauge how strong or weak the trend is. What does that mean/ Remember, momentum is a mix of direction and force. It is not just sufficient to understand the direction of momentum but also the force of momentum. Weak momentum lasts for shorter tenures while strong momentum lasts longer. You need to frame your trading strategy accordingly. Getting the combination right works better!