Momentum Trading

• Many different stock market trading strategies rely on a fundamental trading concept: momentum. At its simplest, momentum trading applies Newton's first law of motion, sometimes called the law of inertia, to the stock market. The law states that until some external force intervenes, an object in motion will tend to stay in motion.
  
  

William O'Neil

• William O'Neil, who founded "The Investor's Business Daily," describes the elements of his classic investment trading strategies in his book "How to Make Money in Stocks." The details of his strategies are beyond the scope of this article, but in brief, he looks for a stock with an accelerating upward market value, "institutional sponsorship" (meaning that the big investment firms, like Goldman Sachs, have a current and growing investment in the stock), increases in trading volume, introduction of new products and annual earnings increases. Lastly, and very important in his view, the momentum trader needs to sell the position whenever the price falls about 7 or 8 percent from its purchase price--not its peak price.
  
  

Momentum Variants

• O'Neil has made it relatively easy for inexperienced traders to follow these precepts which are also followed by professional traders. The Investor's Business Daily newspaper publishes daily ratings based on O'Neil's criteria. Other momentum trading methods use a variety of technical data. Alexander Elder uses the exponential moving average (EMA) to evaluate a stock's direction, another form of inertia evaluation. He then uses the moving-average-converge-divergence graph (MACD) to further identify price points to buy and to sell.
  
  

More Complex Trading Schemes

• With the increasing availability of computers, relatively recent trading strategies have emerged that rely on computer program analyses of increasingly dense data fields. One popular method, particularly for currency trading, the Ichimoku Kinko Hyo, begins with O'Neil's type of momentum analysis, but inserts into the buy-sell decision many more data points to identify a general trading strategy trend.
  
  

Super Computers and Quants

• O'Neil and other successful professional traders analyzed trends. But they did so by studying a few well-known and widely available records, various versions of the moving average, for example. But in the past few years "quants," skilled computer programmers with extensive math and physics backgrounds, have taken over the greatest share of the trading market. Using super-computers, sometimes located within a block of the exchange (because the information will arrive a few nano-seconds faster), high-frequency traders use "algo" techniques--program trading based on mathematical algorithms. They beat the market by spotting trading advantages--market anomalies--that may exist for only a very short time. A typical quant trading house may execute a buy and then a sell order on a stock within a fraction of a second. "This is where all the money is getting made," said William Donaldson the former head of the New York Stock Exchange. But, he added, "If an individual investor doesn't have the means to keep up, they're at a huge disadvantage."