Some traders watch a stock take off then chase it like the crazed neighborhood chihuahua who barks after anything that passes in front of its yard. It may be funny when the chihuahua yaps after dogs many times its size, but the lesson for traders should be clear: risk control must be paramount.
Like the chihuahua, traders who chase every move often enter too late or exit too early. Worse, chasing the wrong setups in the wrong markets often results in small profits, large losses and frustration. Traders who approach markets without using key fundamentals will find themselves in this situation often.
The momentum wave concept can help you with this risk control and give you key fundamental lessons when developing your own trade setups or understanding the inner mechanics of a trading method. By recognizing and implementing this concept, you can begin applying it to your current trading. Included in this concept are a few key principles that when integrated into a sound trading method can help improve your trading. They are the principles of momentum, velocity and compounding.
THE BIG MO’
The principle of momentum in trading relates to the acceleration of a stock’s price action in a given direction combined with return on investment (ROI).
When trading and applying the principle of momentum, try to picture waves coming in and out at a beach. There are large numbers of surfers that swim out to the rough looking to experience the bliss of the perfect run on a great wave.
Now, imagine that you’re a surfer at this beach who is patiently sitting on his surfboard in the rough watching all the other surfers attempt to ride anything, only to end up floundering in the water or experiencing the thrill of a short run on a mediocre wave.
Suddenly, something subtle catches your eye. You position yourself on your surfboard when a wave forms and you’re in the perfect spot to exploit it. You don’t need to make any effort to gain entry on this wave. Simply let it take you along for the ride.
The wave builds strength and momentum. Its power is awesome, and yet you are gliding gracefully in the thick of the wave’s intense rush and effortlessly adjust your position on the surfboard under your feet while exploiting the wave’s powerful move.
Suddenly, you ride the powerful currents of the wave to the top of the crest just as the wave begins to grow ever stronger, ever larger. Many of the other surfers try to latch on to the wave to ride its power but many are too late and others only get in to partially ride the wave without ever enjoying the full move. The great wave surges forward one more time, attracting even more surfers who try to enter the move to enjoy the ride.