Last Updated on Nov 25, 2022 by Anjali Chourasiya
Momentum in the stock market refers to the sustained increase or decrease in the price of a stock. In technical terms, momentum in a stock is a measure of the velocity at which the price of stock changes. In this article, let’s explore what is a momentum stock, factors to consider before searching for momentum stocks, different momentum indicators, and how to find momentum stocks using a stock screener.
Table of Contents
What is a momentum stock?
A momentum stock is any stock that is facing a steady price change (up or down), i.e. the stock is in the middle of a strong bullish or bearish trend. The primary goal behind momentum trading is to buy when the momentum is strong and sell when it starts to fade. Hence, it is important to note that momentum always comes to an end eventually.
Factors to consider before searching for momentum stocks
Below are three important factors to consider before deciding on momentum stocks-
- Timeframe: Sometimes, the stocks have momentum for a few hours, sometimes for days or weeks, and sometimes for even longer periods. Hence, consider the timeframe and the kind of investing you want to do. For instance, stocks with momentum for a few hours are good for day trading, while stocks with momentum for a few months can work for medium-term investors.
- Sector: Look out for sectors that are experiencing strong momentum. Sometimes, a specific sector is experiencing momentum while others are wavering. The same can happen for capitalisation groups, such as mid-cap stocks can experience momentum at a time while others are sitting on the fence.
- Volatility: The volatility of momentum stocks directly impacts your trading/investing risks. Hence, determine your risk appetite before you jump into the pool of momentum stocks.
How to identify stock momentum?
There are several indicators that help in identifying stocks with good momentum. Let’s look at those momentum indicators and how they function.
1. Relative volume
Often called RVOL, relative volume is the ratio of the average volume of the stock over the previous ten days divided by the average volume of the stock over the previous 91 days. It helps in understanding the demand for the stock in the market for the past few days.
The higher volumes can suggest that the stock is of continued interest, whereas low volume indicates a lack of interest in the security (lack of momentum).
2. RSI – 14D
A Relative Strength Indicator (RSI) is a momentum indicator that is used to track the price changes in security. RSI – 14D measures the speed and change of price movement over a 14-trading day period to determine whether a stock is in the overbought or oversold range. A simple average of daily price gains and daily price losses is compared with each other to calculate relative strength.
RSI values range from 0 to 100. A value above 80 indicates an overbought situation for the stock, whereas a value below 20 indicates an oversold.
3. RSI Exponential 14D
It works similarly to RSI – 14D except for the exponential average of price close of stocks for the previous 14 tradable days is used. An exponential moving average is a type of moving average that is similar to a simple moving average, except that more weight is given to the latest data.
In terms of value, RSI exponential above 80 indicates that the stock has run up too much, whereas a reading below 20 indicates an oversold position.
4. MACD line 1 – Trend Indicator
Moving Average Convergence Divergence (MACD) is a trend indicator. It is calculated using the difference between 12 and 26 days Exponential Price Average (EPA). MACD tells us whether a stock is in an uptrend or downtrend.
MACD is extremely helpful in spotting increasing short-term momentum. A positive MACD line 1 value is caused when the 12-day EPA is greater than 26 days EPA. This indicates an increasing upward momentum. An increasing negative MACD line 1 value indicates that the downward trend is getting stronger.
5. MACD line 2 – Signal Line
It is calculated as the difference between the MACD indicator and the signal line. A signal line is a 9-day exponential average of MACD line 1. A positive MACD line 2 value indicated that the MACD line 1 value is greater than the signal line value. There can be different interpretations of this value depending upon the absolute value of the MACD line 1.
For example, if the MACD line 1 has a positive value, it means the stock is in an uptrend. In this case, a positive line 2 value would mean a strong uptrend and a negative line 2 value would mean a weak uptrend.
If the MACD line 1 has a negative value, it means the stock is in a downtrend. In this case, a positive line 2 value would mean a weak downtrend and a negative line 2 value would mean a strong downtrend.
6. ADX Rating – Trend Strength
The Average Directional Index (ADX) is a momentum indicator that measures the strength or weakness of the trend regardless of whether markets are moving up or down. ADX value is calculated over a 14-day period.
It ranges between 0 to 100. If the stock prices have been falling and the ADX value moves above 25, it indicates that the trend is strengthening and prices will continue to fall. If, in a rising market, ADX value moves above 25, it indicates continued bullishness. An ADX value below 20 indicates no trend.
How to find momentum stocks using a stock screener?
You can use all the indicators mentioned above on Tickertape Stock Screener to filter momentum stocks. However, it is essential to keep in mind that entry and exit points are crucial elements of momentum trading/investing. To determine the entry and exit points for a stock and the direction of the trend, several other technical indicators are used, along with the ones mentioned above.
Another point to note is that we consider the stock screener as a tool for long-term analysis. Hence, we only update technical indicators like RSI at the end of the day on the basis of adjusted close price rather than using the current price during market hours.
To conclude
To invest/trade for momentum stocks, a strategy is needed. It helps in making the best use of the oscillations in the price of a stock. As momentum investing involves a lot of technical indicators and experience, it is worthwhile to consult an expert on the matter and use Tickertape Stock Screener for all your research and analysis needs.
FAQs
1. What is momentum investing?
Momentum investing refers to buying and selling stocks that have the potential to yield brilliant returns due to a likely substantial jump in their prices in a short span of time. In other words, it is about buying stocks that are about to soar and selling them at a much higher price. And vice-versa.
2. What are the benefits of momentum investing?
Momentum stocks indicate a high potential for profits over a short period of time. Momentum investors can leverage the shifts in the stock prices that arise due to emotional investors instead of giving in to emotional responses to a stock price. They can take the volatility factor in their stride and use it to their advantage by maximising their returns on investment through momentum trading.
3. What are the drawbacks of momentum investing?
There are several drawbacks to momentum investing, such as –
– It is extremely time sensitive and requires daily monitoring, if not more frequently.
– A momentum strategy is sensitive to the nature/mood of the market.
– If you hire a professional to do momentum investing/trading for you, they come with high fees as the stock turnover is also substantial.
As an insatiable reader and learner, I’ve spent the last two years exploring the world of finance. With my creative mind and curious spirit, I love making complex finance topics easy and fun for everyone to understand. Join me on my journey as we navigate the world of finance together!
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