A momentum trader is a securities trader who takes advantage of market momentum for profits. There are two distinct types of momentum trading, operating in different ways. One hinges on exploiting volatility in response to breaking news, while the other involves engaging in technical analysis to identify over- and undervalued stocks. Both require a high level of skill, as well as a very organized trading strategy to prevent situations where traders get into trouble by exceeding their limits.
In the first sense, a momentum trader acts in response to breaking news. When major news breaks, the market typically becomes volatile in response, even if the news does not have a direct economic impact. People who can enact extremely rapid trades to exploit rises and falls in value can be well positioned to make a profit on the shift in market fortunes. This work requires paying close attention to the news, acting quickly, and being good at predicting market movements.
The other type of momentum trader identifies securities with apparently skewed values. These traders often operate on futures contracts, making arrangements to take advantage of expected falls or rises in value. This type of trading allows people to profit whether the underlying security goes up or down in value; the contract can allow a trader can sell an overvalued stock at a high price when the market value drops, for instance, or buy at a low price when the market value ticks upward.
Momentum trading is suitable for investors of moderate to advanced skill. Beginners can get in trouble with the fast pace and need to be able to predict market shifts effectively and efficiently. One common problem for new momentum traders is panic trades, where the trader is forced into a bad move out of worry about a shift in the market. This can result in a situation where the trader takes a loss, while a more experienced momentum trader would have ridden the panic out and held on to the stocks or waited to buy.
People interested in momentum trading can participate in open outcry trading on the floor of a securities exchange, or trade electronically. The best method depends on the market, the trader's comfort level and experience, and the tactics being used. To trade on the floor, a momentum trader may require sponsorship or the ability to buy a trading seat, depending on how the stock exchange is organized.