What is Momentum based Algo trading?
Owing to the own rationale that says "buy
high and sell higher," momentum investing is a fascinating tactic.
Investing based on momentum sounds less like an investment plan and more like a
mind-boggling response to information about the market. Selling losers and
purchasing winners is the principle of momentum trading. In clear terms,
investing in momentum is a trading tactic in which investors purchase and sell
shares that grow as they appear to be at their highest. The goal is to exploit
the volatility by finding buying opportunities to buy rising securities in
short term and sell them when they start to lose momentum. The investors
take the cash and start looking and repeating the same process for the next
short-term uptrend or purchasing opportunities. Professional traders have a
good knowledge of securities that lets them know when to reach a position, how
long to keep it, and when to sell it. They also have great presence to
short-term news driven changes or selloffs.
Driehaus Capital Management was founded by
Richard Driehaus, one of the founders of momentum trading techniques, and
reportedly delivered 30 percent compound returns in the first 12 years after
its inception. He took this method and converted it into a technique used by
him to run his funds. His theory was simple: "Buying high and selling
higher" would make more money rather than the dull thought of buying
underpriced stocks and waiting for them to be re-evaluated by the market. From
212 years of US equity results, the success of the momentum strategy is indeed
evident. Driehaus believes in selling the losers and having the winners to lead
while re-investing the losers'' money in other stocks that seemed to be boiling.
Types of momentum trading
Momentum is present in multiple types of
assets and throughout geographies. You can deal in two ways by using
momentum, namely—
1 Time series momentum.
2 Cross-sectional momentum.
Time series momentum-
If the past returns and performance of the
securities are positively related to its future performance then its known as
time-series momentum.
Cross-sectional momentum.
Cross-sectional momentum is based on price
trends between different markets or securities in cross-section. Cross-section
momentum looks at the relative strength of a cross-section of markets. It is
ranked based on their relative strength momentum to determine which markets or
stocks have gained more and which have gained less.
Key points to keep in mind while going for
momentum trading
· Do
not look upon leveraged or inverse ETF’s because their price swings fail to
accurately track underlying indices or futures market due to complex fund
construction.
· Seek
out for securities that trade more than 5 million shares per day.
· Keep
an eye on “flavor of the day’ when new products, diversions or concepts capture
the public’s imagination.
· Bio-techs
and small to midsize technology companies create a tremendous supply of these
story stocks.
Actions to avoid while momentum trading
· Jumping
into position too soon, before a momentum move is confirmed.
· Failing
to keep eyes on the screen, missing change in the trends, reversals or signs of
news that take the market by surprise.
· Closing
the position too late, after saturation has been reached.
· Keeping
a position open overnight. Stocks are particularly susceptible to external
factors occurring after the close of that day’s trading-these factors could
cause radically different prices and patterns the next day.
· Failing
to act quickly to close a bad position, thereby riding the momentum train the
wrong way down the tracks.