The momentum of a trend

Momentum is the juice behind the development of overbought and oversold oscillators. According to Newton, momentum is the combination of mass and velocity. Newton said that momentum represents the ability of an object to move in one direction at an even speed until an outside force slows it down or stops it.

The risk involved with trading along trend-following techniques is the prospect of missing the initial reward when the trend is changing direction. The risk-reward ratio of picking the top or bottom of a trend does not work in favor of traders or investors in the long run. Attempting to go long at the bottom or short at the top of a trend has destroyed more traders than any other trading technique. The risk-reward ratio improves dramatically for traders who focus on catching the meat of the move by going long or short once a trend is in place.

One reason traders feel such a need to pick the bottom or top of a move is that many have a deep-seated desire to be proven right. Rather than selling part of a long position if they think the trend is at the top, or waiting for confirmation that a top has indeed formed, their egos coax them on, encouraging them to take a shot and go short. If the initial guess was wrong and the trend was not at the top, their egos tighten the grip. The traders, not wanting to feel half-wit-ted, either add to their losers or let them run.

It seems reasonable to short a stock that has risen high, or to buy a stock that has swooped low; but what is high and what is low? Most traders have their own definitions of high and low. Successful traders do not make money by buying low and selling high; they make money by buying high and selling higher, or shorting low and buying lower.

Methods such as oscillators and basic chart patterns will help you isolate when a trend is in the process of changing, and allow you to wet your beak on some of the volatility that takes place when markets turn. The first step, however, is to use perceived inflection points of tops and bottoms of trends as areas to trade around existing positions. Rid yourself of the belief that for every successful trade there is one entry point and one exit point. The most profitable traders trade around a core position, constantly scaling in and out. If your signal is telling you that the market is forming a top, use that signal to sell part or all of your long position. Refrain from trying to short a perceived market top.

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