Although technical traders look to follow trends in the stock market, they also look for situations where the trend changes so that they can find new profit opportunities. In general, day traders are going to follow trends, and swing traders — those who hold securities for a few days or even weeks — are going to be more interested in identifying changes that may play out over time.
Momentum
Following the trend is great, but if the trend is moving quickly, you want to know so that you can get ahead of it. If the rate of change on the trend is going up, then rising prices are likely to occur.
To calculate momentum, take today’s closing price for a security, divide that by the closing price ten days ago, and then multiply the result by 100. This gives you a momentum indicator. If the price didn’t go anywhere, the momentum indicator is 100. If the price went up, the indicator is greater than 100. And if the price went down, the indicator is less than 100.
In technical analysis, trends are usually expected to continue, so a security with a momentum indicator above 100 is expected to keep going up, all else being equal. But it’s that “all else being equal” that’s the sticky part. Technical analysts usually track momentum indicators over time to see whether the positive momentum is, itself, a trend. In fact, momentum indicators are a good confirmation of the underlying trend.
Momentum is a leading technical indicator. It tells you what is likely to happen in the future, not what has happened in the past.
Momentum trading is usually done with some attention to the fundamentals. When key business fundamentals, such as sales or profits, are accelerating at the same time that the security is going up in price, the momentum is likely to continue for some time.
Find breakouts
A breakout occurs when a security price passes through and stays above — or below — the resistance or support line, which creates a new trend with new support and resistance levels. A one-time breakout may just be an anomaly, what technicians sometimes call a false breakout, but pay attention to two or more breakouts.
When a true breakout occurs, a new trend starts. That means an upward breakout will be accompanied by rising prices, and a downward breakout will be accompanied by falling prices.
False breakouts can wreak havoc for a day to two of trading. With a false breakout, some traders buy or sell, thinking that the trend will continue. When they see that it doesn’t, they then turn around and reverse their positions at a loss. During these times, the ability to size up the intelligence of the other traders in the market can come in handy.
Good technical analysts look at several different indicators to determine whether a change in trend is real or just one of those things that goes away quickly as the old trend resumes. For example, they make look at short interest or overall market volatility.
