A Lesson On Momentum

by | May 30, 2024

A Lesson On Momentum

The last couple of weeks, I have inundated you with Fed updates and macro headlines.

Today, let’s switch gears and get a little tactical:

A Lesson on Momentum

When I think about momentum and why I love it so much, a lot of other random thoughts that are closely (and sometimes not so closely) related come to mind.

For example, one thing I love about momentum is its simplicity:

When you’re trading momentum, you really don’t need to worry about many factors beyond what you see on the chart. You’re not concerned about fundamentals, sentiment, or even other indicators… you just want to see if a stock is moving fast enough to convince you that it can keep going.

I think we tend to overcomplicate the stock market by considering a whole heap of details that probably won’t translate to a stock changing value (especially in the short term when we plan on trading it).

For me, the most obvious factor is typically staring us right in the face in the form of momentum.

Now, that’s not to say that momentum always gets it right. After all, the market has many turning points in the midst of momentum moves…

But if I wanted to know if a runner in a marathon could finish the second half of the race with speed and power, the first thing I would do is look at how he performed in the first half of the race.

I recommend looking at stocks the same way (again, at least as a starting point).

Another thing I love about momentum is that you cannot miss a trend. We all know trends are the most powerful opportunities in the entire stock market, and there are a lot of methods that can totally miss out on trends… momentum isn’t one of them.

It’s funny; I often hear people say things like, “Oh, I missed that big run in XYZ stock,” but the reality is it’s impossible to miss if you’re just watching the chart.

Look at something like NVDA or CCJ or LLY or countless others… The talking heads probably said they were overvalued or overbought, and even a lot of great trending strategies would consider those stocks valid “opportunities” but never found an entry point.

On the other hand, momentum doesn’t consider anything overextended and simply buys based on the idea that it’s already moving fast and strong. Momentum never misses a trend.

Some Practical Steps for Measuring Momentum

As I said, I don’t think you need an exact science to trade momentum…

The basic eye test is going to tell you, for the most part, if a stock looks to be moving consistently with strength and speed in a particular direction (look at NVDA or CCJ or LLY on a zoomed-out chart… you will see lots of momentum). But let me give you a couple more tangible ways to leverage momentum.

#1 Multi-Time Frame Momentum

The only thing I like more than daily momentum is when it also matches weekly momentum and 4-Hour momentum (i.e., the time frames on either side of the one I want to trade).

This is one of the easiest ways to gain an advantage in the stock market. In fact, I think if the only thing you take from this report is to confirm opportunities by ensuring that there is a weekly trend and weekly momentum on a stock you want to trade, you will make a huge leap in your overall trade (bonus points for monthly trends).

From there, just wait for the time frame below the one you want to trade on to show momentum, especially if there is a slight pullback to optimize your entry.

#2 Broad Market Trend Alignment

For me, the idea of momentum is pretty simple: buy high and sell higher. To leverage that concept, I want to make sure that everything in the market is aligning with continued momentum; therefore, I do not want to trade against the broad market even if the individual ticker is showing momentum.

In general, stocks that align with the broad market have a higher probability of moving in that direction.

So, if you’re looking to trade momentum, you just don’t want to have the broad market working against you.

#3 Candle Sizes

Okay, this is my favorite and kind of the “secret sauce” behind how I’ve been approaching momentum lately. Now, I say secret sauce lightly because it’s not like this is actually that complex or technical; however, I find it to be very effective.

All I’m doing is measuring the length of a candle from its highest point to its lowest point and comparing that to the price of the asset to come up with a percentage net movement of the candle.

I don’t care how much of that candle is body versus wick; I only care how much it moved from high to low and whether it closes as a bullish candle or a bearish candle.

What I found, I suppose not surprisingly, is that larger candles (especially after pullbacks or rest) have a higher degree of follow-through than a series of smaller candles.

In fact, in a recent strategy test I was working on, I used the same set of criteria with one change being that I required the candle to be double the movement of the average candle, and I was shocked to see the accuracy of the strategy nearly double.

I have continued to use this candle size as a filter, especially for momentum strategies.

Now, it’s hard to explain all the dynamic ways to use this filter because it depends on the average range of the asset along with what time frame you’re using it on and several other factors, but I have created a simple, free indicator through the TradingView platform that will help you play around with this candle size filter and apply it to your trading if you choose.

You can access this free momentum indicator right here in my telegram channel. You’ll find it in the “pinned messages” section at the top.

Just to be clear, this indicator should never be used as a standalone strategy, so I would never recommend taking an entry purely based on the size of the candle.

But I found it to be a great complement to my strategies and I recommend you check it out.

If you apply this to any of your strategies or take any trades using it as a filter, please let me know. I would love to see your feedback!

— Nate Tucci

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