Traders' views - Spread betting

Put some oomph into it - don’t leave your trading to chance

By , 28 Jun 2012

It’s nice capturing the whole of an up/down move when trading. You feel superior having correctly called the top/bottom of the market. But focusing on this can be risky.

There is no guarantee the price will turn in your favour. Unless you’re extremely strict with yourself, closing out of loss-making trades early to protect your capital, the 50/50 element involved in calling the market can be dangerous.

CFDs and Spread Betting are designed to magnify trading gains. While they work well if you call the market correctly every time, this is unlikely, and the trade-off is that the leverage also magnifies potential losses. For this reason they are better suited to piggy-backing existing price momentum. Scaling up a small move within a trend which is likely to continue puts a lot less down to chance.

A tool that short-term traders (equities, indices, commodities, Forex) can use to help identify trends that  have the potential to continue as well as potential opportunities for price reversal is Momentum. Available on most charting packages, the indicator is a simple trend-following oscillator (moving around a centre line) which can be placed below your normal price graph (see below).

Momentum tracks the rate of change of a price over a specified time period. It plots the historic difference between a price and the price 12 periods earlier (this can be configured as you see fit - minutes, hours, days? 12 periods, 17, 25?). The resulting graph line can confirm when the price is in an uptrend or downtrend and whether a price move it is gaining or losing steam.

Momentum indicates an uptrend when both it and the price display rising lows or a downtrend if both show falling highs. There are four trading signals that Momentum can produce;

  1. If a trend has momentum, we deem it likely to continue which presents a potential opportunity to piggy-back the price move for a short while.
  2. When Momentum crosses the zero-line from below, this can be taken as a potential buy opportunity. The price differential (and thus the price) will have to have been rising, meaning upward momentum behind it.  A cross from above can be considered bearish, for the reverse reasoning.
  3. Divergence occurs when momentum is moving contrary to price and can be a potential reversal signal. Negative divergence requires waning momentum whilst the price pushes higher, suggesting the price may top out and fall back. Positive divergence - momentum bottoming while the price is falling suggests the price may bottom out and rebound.
  4. When Momentum reaches extreme highs/lows and turns back, it is generally accepted that the trend will continue, so beware of pre-empting (calling the top/bottom). This makes sense as the momentum indicator would have a long way come back before getting to the zero-line (the point at which the price differential starts reversing positive to negative or vice-versa.)

 

In the above graph, we highlight several instances where the German flagship equity index (DAX 30) saw its momentum flag up potentially tradable price moves.

  1. Uptrend in process with both price and momentum showing rising lows. Subsequent price move was significant.
  2. Momentum makes extreme low and pulls back sharply, but price keeps moving lower
  3. Momentum shows falling highs (waning momentum) while price pushes higher.  Negative divergence. Price then subsequently reversed strongly.
  4. Momentum shows rising lows while price is falling. Momentum building. Positive divergence. Could lead to price reversal (not a recommendation, purely an observation).
  5. Small circled arrows indicate a couple of instances where momentum crossed above/below zero-line which can produce Buy and Sell signals.

Momentum is one of many indicators in technical analysis, which, by manipulating price data and displaying it in another way, can help provide trading signals. Using Indicators can increase the chances that your trading is profitable. Many factors may be pointing in your favour (Price patterns, volume) but Momentum may suggest the current short-term trend is losing steam.

Try adding Momentum to your price graphs (long or short-term) and look for some of the signals we have discussed. You may be surprised at how frequently they appear.

 

 

This article does not constitute a personal recommendation. It does not take into account your personal circumstances or appetite for risk. Leveraged products involve a high level of risk and you can lose more than your original investment. They are not suitable for everyone so please ensure you understand the risks involved and if necessary please obtain investment advice from a financial adviser before investing.

Warning: Remember, particularly if you are new to trading in the stock market and in forex, that the prices of shares and other investments can fall fast and you may not get back the money you originally invested. The material here is for general information only and is not intended to be relied upon for individual investment decisions. Take independent advice before making such decisions. Also, the BullBearings free stock exchange simulation portfolios are a good way to practice trading techniques.

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