The momentum indicator is key to finding winning trades, and in fact, it’s one of the indicators (after price and volume) that I watch closely. However, it has been very hard to find sustained momentum during this bear market. It’s one of the (many) reasons trading in a bearish environment is so hard.
What is momentum?
Webster’s Dictionary defines momentum as the quantity of motion of a moving body, the product of mass and velocity.
I’m not going to explain the laws of physics here – just how it applies to trading. When a large body (mass) such as the stock market shows some velocity, it can produce momentum in either direction. It is a simple math equation: momentum = mass x velocity. As the SPX 500 has grown over the years, the size of it, coupled with high velocity, can produce incredibly strong momentum.
How does momentum affect trading in a bear market?
During a bull market, we have the luxury of waiting patiently for a trend to establish and then slowly, gently climb on board. But since the start of the bear market in 2022, those trends have moved quickly. A stock can hit a higher level and then reverse suddenly in the other direction. The big, fast moves up or down are not sustainable, because they lack momentum. Yes, they have velocity, but they don’t have enough to change the overall trend.
This scenario played out often in 2022. Several moves down would reverse upward, giving the bulls hope. Then they’d reverse back down, smashing all bullish hopes into little pieces. Such is the action in a bear market. Moves down happen with so much more velocity that momentum ends up pushing the market or a stock to levels below where most market watchers would expect. Thus, an overshoot in momentum down is often accompanied by a snap higher.
Why the momentum indicator is key for options traders
Option traders seek out momentum. It is the momentum of a stock that helps us determine the best short or long term option trade. A stock that shows strong momentum can overcome the time decay factor that is ever-present in options. Stocks like Tesla (TSLA), Microsoft (MSFT), and NVIDIA (NVDA) often show tremendous momentum in both directions, allowing the option buyer to take advantage of the leverage offered by buying calls and puts.
These stocks are not the only ones that exhibit strong momentum. Look for others on your stock chart list to find the best performers with good momentum trends. If those stocks can jump ahead of the time decay or theta burn, you can win.