Understanding momentum is important to the trader. Going long while the market is selling off is an example of a trader not understanding the market’s momentum. Or he was a scalper playing a pop, knowing full well it was only a scalp.
MomentumMerriam-Webster Definition
2 : strength or force gained by motion or through the development of events
I chose this definition because trading sites reference something else regarding momentum. Also I want to stay consistent by the main premise of this technical perspective that I’ve gained. As you know, I’m big on Accumulation and Distribution. To me those are the primary mechanisms of moving the market up or down.
So lets break this definition down for our purposes…
2 : strength or force gained by motion or through the development of events
In grade school, you learned a little about physics, specifically kinetic energy, and potential energy. Many of my mentors always said… “…the wider the base, the larger the space“. This statement is not reserved for explaining a pop or rally, also for a sell off. It describes a market going sideways for sometime and then expelling that potential energy by moving the price. Ultimately what we are describing are results of accumulation and distribution.
On many occasions, you will hear traders talk about consolidation. They usually say the market is trying to decide which way to go. Its waiting for the earnings report, the report on this and that and or the government to speak. But for me, consolidation is a flag.
“…start to top or trade sideways…”
“…start to base or trade sideways…”
For me, I know that the market has already decided. This is where you use comparative analysis to your advantage. What? Flip through your charts of different timeframes and examine the trend. Generally, where ever you are noticing the sideways movement, you want to look at the next adjacent higher timeframe. So if I am in the hourly, I would look at the 2hr, and then maybe 4hr. If it is still not clear, I’ll look at the daily and then weekly. You must not trade on 1 chart, 1 timeframe only. How can you gain perspective of what the market is going to do, without you understanding what it is already doing? Understanding of the picture of the immediate situation, the intermediate outlook and the long term outlook. Give your-self the advantage to limit your risks. Understand the big picture. Not just the one in front of your nose. Look at those charts with purpose. Is this Accumulating or Distributing? Where is this current action with respects to the intermediate and longer term trend? Are we being subdued or supported by a long term level? How significant are the levels above and below?
Signs of Distribution
Bear Wedge, Double Top, Head and Shoulders
Signs of Accumulation
Bull Wedge, Double Bottoms, Inverse Head and Shoulders
There are other patterns mind you, these are the most common and prevalent.
In order to recognize some of these patterns, should you limit your-self to a 1 year chart? NO! Why limit your vision? Some patterns take mins, hours, days, weeks, months and years to develop.
In order to understand momentum, you must understand what caused it.
This concludes this first primer on momentum.