Simply put, momentum is what day trading is all about. This is because the only way you are ever going to find a profit while day trading is by finding the stocks that are moving the most in any given day. Luckily, each day, it is not unrealistic to assume that you will be able to find at least one stock that will move as much as 30 percent. The stocks that makes these types of moves tend to all share a few common technical indicators.
Anatomy of momentum stocks
High momentum stocks will all typically share several things in common, so much so that, when given a list of 5,000 stocks, you can typically narrow the list down to 10 or less per day.
Float: First and foremost, you are going to want to look for those that have a float of less than 100mil shares. Float refers to the total number of shares that are currently available. Float can be determined by taking the total number of outstanding shares and subtracting from it the number of shares that are currently closely-held as well as those shares that are restricted. Shares that are closely-held are those that are owned by employees, major shareholders and insiders. Restricted stock shares are those that are held by insiders and are currently under a lock-up period or other temporary restriction. The smaller the float, the more volatile the stock is likely to be. Small float also indicates low liquidity and a greater ask-bid spread.
Strong daily charts: It is important that the stocks you chose are consistently above their moving averages and are trending well away from any potential support or resistance depending on if you are following an upward or a downward trend.
Substantial Relative Volume: Ideally, you will want to be on the lookout for stocks that are at least twice what the current average is. The average you are comparing to will be the current volume versus the historical average for the stock in question. Standard volume resets every night at midnight so this is a great indicator for which stocks are seeing the most action in the moment.
Fundamental catalyst: While not required, you may also find it helpful to choose stocks that are currently gaining a momentum boost from external sources. Things like activist investors, FDA announcements, aggressive public relations campaigns and earnings reports are all likely to jumpstart momentum.
Strong exit indicators
In addition to knowing what a viable stock to trade based on momentum looks like, is also important to know when you are going to want to get out to ensure you don’t lose the profit you have made. Keep the following in mind and you will be able to hold onto all your hard work more reliably.
When you hit your profit target: If you hit the profit target you were aiming for them the best choice is to sell off half of your holdings and then adjust your stop loss to account for the potential for additional gains.
Red candles: If you haven’t yet reached your profit target, if a candle closes out red then you should take this as an indicator to exit. If you have already sold off half of your holdings then you are going to want to hold through this first red candle as long as it doesn’t trigger your stop loss
Extension bar: An extension bar is a candle with spike that causes dramatically increased profits. If this occurs you want to lock in your profits as quickly as possible as it is unlikely to last very long. This is your lucky day and it is important to capitalize on it.
Find the right screener
In order to use a momentum strategy successfully, you are going to need to use a reliable stock screener to find stocks that are trending towards the extreme ends of the market based on the above criteria. Screeners are an indispensable tool when it comes to narrowing down field of stocks that are right for you on any given day. The best screeners allow you to add in your own filters and then only display the stocks that meet all of the criteria determined. The following is a list of the most popular free screeners on the market today.
StockFetchter.com: StockFetcher can be a little complicated, but those who take the time to learn its ins and outs agree that it is one of the most powerful screeners on the market today. This power is due to its practically unlimited number of custom parameters and filters which allow you to create your own screens. The free version of this service will then allow you to see the top 5 stocks that match your criteria which is often enough to find a few worthwhile trades each day. There is also an upgraded version which will show you all of the available results for just $8.95 per month.
Finviz.com: Finviz offers thousands of premade filter combinations to return results on the most promising stocks for a given day. The tool is extremely easy to use as it offers three main drop-down menus, technical, descriptive and fundamental, and lets you choose one or more criteria from each. Results can then be sorted in 14 different ways to ensure you can always find the stocks you are hoping for. Be aware, however, that Finviz uses delayed data which makes it most effective for those who run their screens in the evenings in preparation for the next day’s open.
Chartmill.com: Chartmill allows you to filter stocks based on standard criteria such as candlestick patterns, technical indicators, volume, price and performance. It also offers proprietary filters including things like trend intensity, squeeze plays and pocket pivots. Chartmill works via a credit system and provides each user with 6,000 credits per month free. Each scan then costs a few hundred credits which means most users can take advantage of their tools free of charge. Additional credits cost $10 per 10,000 or they have an unlimited option available for about $30 per month.
Stockrover.com: Stockrover is a useful tool if you are interested in trading in the Canadian market as well as the US market. It utilizes fundamental filters along with those that are performance and technical based. This tool allows you to track stocks that are near established highs and lows, those that are gaining momentum and even those that are currently being traded by major hedge funds. It also allows you to create custom screens and to create equations for more advanced screening. It then allows for backtesting to ensure the equations are up to snuff. Most of their options are available to free users but some features are gated behind a price tag of $250 per year.
Choosing the right filters
As a day trader, you are going to want to not only find stocks that have a high volume, but those that are currently experiencing a high degree of movement as well. In order to find the stocks that are going to see the greatest degree of movement, consider the following filters.
Constant volatility: In order to trade the most volatile stocks with the least amount of research try the following list of criteria in your favorite screener that allows for personalized screens. While more research is always better, you can even see success running this screen once a week and then trading the results for the coming week.
This criterion will then return stocks that, over the past 50 days, have moved at least 5 percent each day. It is important to use at least 50 days, though 75 or 100 are going to produce even more reliable results. This shows that a given stock has moved a significant amount repeatedly over the past few months. The second criterion determines the amount you are willing to pay per share and can be altered based on your specific needs.
The next criterion determines the amount of volume you are looking for in a given timeframe. The example looks for volume over 4 million shares in the past 30 days. Next, this criterion eliminates leverage ETFs from the results which can be eliminated if you are interested in trading ETFs. Finally, the add column will show a list of the stocks with the largest volume and the greatest amount of movement. Selecting these columns will rank the results from lowest to highest based on the provided criteria.
Monitor daily to find the biggest moves: Alternately, you may prefer to search every day for the stocks that are likely to experience the greatest range of movement. To do so, you will want to create a new list of stocks each evening so that you are ready to go for the next morning when the market opens. This list can be made up of stocks that have a high volatility during the preceding day, either the greatest percentage of gains or losses. Adding in volume criteria will then help to make sure the results will continue to generate the kind of volume day trading requires. Useful filters for this search include an average volume of greater than 1 million, the greater the volume, the fewer results you will see.
When using this strategy, it is important to take note of the well-known stocks that are likely to see news release as these can often cause price movement that is unpredictable unless the details are already known. It is best to wait until after these releases have gone public to begin your trades as this is likely when both volatility and volume will be at their highest point. If you don’t have your own, the earnings calendar found at Yahoo! Finance is a great place to start.
Intra-Day volatility monitoring: Another viable option is to do your research during the day to determine the stocks that are experiencing the highest degree of movement. Most trading platforms provide this information in real time. This makes it easy to keep abreast in changes that occur throughout the day. As an example, if a stock opens at a point down 10 percent from its previous close and stays there, then you know there isn’t any trading happening there. However, if it starts at 10 percent down and keeps dropping then you can start considering it for a potential trade. You may also find it useful to track stocks that are currently breaking their established resistance levels.
Find the biggest moves: In order to find the stocks that are very likely to make big moves without committing to constant research, you will want to focus on stocks that are proving to be constantly volatile. This is another scan that can be run over the weekend to prepare for the week ahead. Alternately, you can run this scan each evening and monitor the differences daily instead. Additionally, you may want to monitor volatility during the day to determine which stocks have been the most active during the current session.
Double check the details with chart patterns
After you have found a stock or 3 that your scanner of choice says is likely to move with the momentum you are looking for, the next step is to double check that information. This means you are going to want to start by reviewing its candlestick chart and try to determine the correct entry point based on the first pull back. It is common for traders to simply buy at the point of pull back which then creates an additional spike in volume which pushes the stock price up further. Finding the best entry point in real time is key to long-term success as a day trader.
Pennant: A pennant forms when there is significant movement in a given stock followed by a consolidation period which causes the pennant shape created by a pair of converging lines. A breakout is then likely to occur in the same direction as the previous movement. There will likely be significant movement at first, followed by weaker volume as the tip of the pennant forms, followed again by strong growth and additional volume after the breakout.
Cup and handle: The cup and handle pattern looks like the bowl of a cup with the ride side handle. The pattern is u-shaped, charting a series of lows for the stock while the handle also slopes slightly downward. This is a sign that volume is going to remain low overall and that the stock in question should be avoided.
Ascending triangle: This pattern typically forms during an upward trend and indicates that the current pattern is going to continue. It is a bullish pattern that says greater growth and volume are on the way. It can also be formed during a reversal, signaling the end to a downward trend.
Triple bottom: The triple bottom, named for the 3 bottoming out points of a given stock, tends to indicate that a reversal is on the way. You can tell a triple bottom by the fact that the price rebounds to the same point after each period of bottoming out. After the third period, it is likely to reverse the trend by breaking out.
Descending triangle: This is similar to the ascending triangle but is bearish rather than bullish. It indicates that the current downward trend is likely to continue. It can occasionally be seen during a reversal but is much more likely to be a continuation.
Inverse head and shoulders: The inverse head and shoulders consists of 3 low points always returning to the same higher price. The lowest point is considered the head while the shoulders are a pair of low points that are equal to one another. After the second shoulder, a breakout is likely to occur that will pick up volume as it goes.
Bullish triangle: This is a symmetrical triangle pattern that can be easily determined by a pair of trendlines that converge at a point. The lower trendline tracks support while the upper tracks resistance. Once the price breaks through the upper line then you know that a breakout has occurred that will rapidly pick up both steam and volume.
Rounded bottom: This pattern tracks a prolonged drop in price that will eventually rebound back to the point where it started. After the rebound occurs a reversal and breakout is likely to occur though it is best avoided as the new trend is likely not going to be strong enough to suit your day trading purposes.
Flag continuation: This pattern forms a rectangle with the support and resistance lines remaining parallel to one another. The slope of the parallel is likely to move counter to the original price movement. The point where the price breaks through can signal a strong indicator to buy or sell based on the direction of the breakout.
Bearish triangle: This triangular pattern is easy to identify because the support and resistance lines converge in a downward slope. The breakout point is always going to be on the support side and indicates a strong downward trend is forming that is likely to pick up volume significantly as it goes along.
Falling pennant: This pattern looks a lot like a triangle pattern except it doesn’t quite come to a point. The trendlines will connect several peaks and valleys and once the breakout occurs it is likely that the price will move sharply in the direction of the breakout.
Double top: This pattern involves a pair of trendlines that are a good distance apart that track a price through a pair of significant downward movements that both return to the same high point in between. Once the price breaks through the support line then you can count on significant downward movement in the near future.
Head and shoulders (standard): This is the opposite of the inverse head and shoulders discussed above. It is created by three distinct price points, one at a higher point than the other two which all return to the same low point in the interim. The breakout will eventually come at the support line and will indicate the start of a new downward trend.
The importance of the bull flag: Of the patterns that you are likely to run across most frequently, the bull flag pattern may well be the most important. It is a flag that you are likely to run into every day and it provides the ability to enter at a low risk point on otherwise very strong stocks. With this pattern, you are going to want to look for an entry point after the first candle that creates a new high after the breakout has already occurred. To find this pattern, you simply keep an eye out for stocks that are squeezing up and forming tall candles. You then wait until these have formed 2 or 3 pullback candles.
The first candle to perform positively after this occurs is where you will enter, while placing a stop loss at the low point of the pull backs. It is important to get in quickly after the candle high point as right after this the volume typically spikes dramatically.
Other things to keep in mind
Setting stops properly: When it comes to day trading you always want to keep a 2 to 1 profit/loss ratio. As such, you are typically going to want to set a tight stop that is just below the first pullback point of the stock in question. A good profit target is typically 40 cents per share, which means that you are often going to want to set your stops 20 cents lower than your target. If the stop is greater than 20 cents then you may want to manually end the trade and come back for a second try. This is a good strategy because generating stops at greater than 20 cents means you quickly need to make $1 or more per trade which can be harder than it might first seem.
You will find that it is much easier to find success with 40 cents worth of profit as opposed to setting a stop of $1 and trying to make $2 of profit, the day trading market is simply too volatile for this to be successful in most instances. Your goal here should be to balance your level of risk across the entire time you spend trading. The easiest way to calculate the specific risk of a given trade is to determine the distance between the entry point and the stop. If you have a stop set at 20 cents and want to ensure the total risk is no greater than $500 then you will be able to worry about 2,500 shares at a time.
Ideal time to trade: While you can use momentum trades successfully at any time between 9:30 am and 4 pm, you will typically find them most successful between 9:30 am and 11:30 am. With that being said, if there is an incoming news release it will likely be worth your time to trade once it has been announced, regardless of the time of day. After 11:30 am, you will likely have the best results working from the 5-min chart exclusively. The 1-minute chart typically becomes much choppier after 11:30 am which can make it difficult to set stop losses effectively.
Analyze your results: Trading successfully in the long term is all about statistics which means you are going to want to keep an eye on your success/loss ratio every day to ensure that you are always moving in the right direction. At the end of each week you are going to want to determine your current trading metrics. If you have a month’s worth of subpar metrics then you are going to want to take a serious look at your trading strategy and determine what you can do to change it for the better.