Momentum Trading – everyone’s favorite way to lose money.
It looks so easy, right?
A low float, heavily shorted stocks that nobody has ever heard of until that morning is suddenly jumping on huge volume.
Yesterday it was at $4.15, but pre-market it hit $7.20! It opened to $6.10 and it is starting to go! Rocket emojis are flying, people are saying things like, “Next stop $10!” and then some weird shit about eating at Wendy’s that night.
But wait – you’re not just going to jump right in, no no, not you – you’re smarter than that – you will look at some charts first! Maybe you check the daily chart and see a few months ago it hit $22. Great, there is room to grow! Damn, there are a lot of bag-holders too! Guess which one of those two arguments win out? Room to grow!
Next you continue the process of fooling yourself into believing that this trade is based on rationality by looking at the price action. The 5-min chart? The 1-min chart? Hell – both of them! Let’s throw some EMA’s on there, and keep an eye on that volume – because now it is all about the….pullback.
Perhaps it is the 3-bar method, or the 8-EMA – there are just so many to choose from! For every method there is a YouTube video of a someone in a rented Lambo, with around 10 monitors behind them, and they are going to show you how they built their amazing fortune.
Finally, you pull trigger – 1,000 shares of Stock IDAF @ $6.34. BAM! Now sure, you only have $7,200 in your account – but with margin taken into account you still have more than half of your buying power left, so you are Golden, Pony Boy. Nothing to worry about.
There is a quick little pop up to $6.66 (yes, intentional), you’re up $320 and thinking to yourself, that you are going to shoot for $7.10, right under the pre-market high – I mean, why get greedy right? Or perhaps you are conservative, and decide that .50 cents is nice round number, and make $6.84 the promised land.
Doesn’t really matter where that target is, because we all know how this story goes from here, don’t we? IDAF decides to back off a bit and perhaps say hello to its’ old friend, VWAP. Now it is at $6.03 and you are down $310 – that’s a $630 swing – What. The. Hell. Not cool. Not cool at all. But this stock is wild, it can do anything! No way are you getting out now only to see a long green candle mock you from your screen.
Flash forward an hour – IDAF has bounced off VWAP three times and once it almost got close to your breakeven, and your finger was hovering over the sell button, but you didn’t do it – because it’s finally going back up! Either way, you put your hard stop right below VWAP. Done.
Flash forward another hour – Well so much for hard stops huh? You have now invested way too much time to get knocked out of this trade now. Plus, you just read that IDAF had really positive results from some trial of some drug that cures some disease and everyone on Stocktwits is saying it is going to $10, and everyone on WSB’s is saying “Screw $10 – $100 or nothing!”. IDAF is now at $5.95.
Two Hours later – Remember that extra margin you had? Dollar Cost Averaging Baby! (or that is what you say, because it sounds good – but really you mean – averaging down) 1,500 shares now @ $6.19. IDAF is now at $5.73 – volume is almost non-existent, until….BAM, huge volume, IDAF is going again! It’s at $5.85. It’s at $5.97. It’s at $6.04. Holy shit – it’s coming back!!
End of the Day – IDAF is now at $5.23, and you are down $1,440. You sell. You’re depressed. Before you head off to open that bottle, you take a last look at the chart – IDAF is at $8.25 and climbing.
Tears begin to fall.
Does any of this sound familiar?
Why does it happen?
The problem isn’t in technical analysis, the problem is in your head.
Traders have two big mental issues (well, more than that, but for the purposes of this post, there are two) –
1) We take profits too quickly. Always afraid of having our gains taken away from us, we let fear guide our decisions. And why not? Whenever something good happens in our life it is only a matter of time before the other shoe drops, right? Instead, we should be adding to our winning trades, there are many reasons to exit a trade (e.g. stock lost Relative Strength to the market, it got rejected at strong support, volume dried up, etc.) but fear should never be one of them.
2) We hope our losers will turn around. Always thinking that the moment we sell, the stock will turn around, we stare at the screen, trying to get a reversal through sheer willpower. And why not? We have spent most of our lives hoping things will turn around. You’re due. At some point things have to get better, don’t they?? And so instead of exiting, we do the opposite, we double down on our mistake. We are averaging down when instead we should be looking at the charts without emotion and asking if the reason you got into the trade still applies? If you weren’t in the trade, would you enter it now given the current conditions?
These issues are difficult enough to deal with when you are trading a stock like MCD or AAPL – but when you are trying to scalp IDAF?? Exponentially harder. Why? Because IDAF can turn around. IDAF doesn’t care about VWAP or EMA’s, it is a piece of shit, low float, highly shorted stock that at any moment can suddenly jump from $5 to $8, and so in your mind there is reason to hope. Yeah, MCD is most likely not going to rebound when SPY is dropping and it fell below it’s 50 SMA on the daily chart, at least not on that day it won’t – but IDAF can – and that keeps you in the trade.
This is why I say that momentum trading is the most difficult kind of trading there is, and unfortunately it is also the most common method used by new traders. Experienced, profitable traders know how to mentally prepare themselves to scalp IDAF, but it takes a long time to get there.
So if this story resonates with you, please, do yourself a favor and stop . There are so many ways to Day Trade, and opportunities to make money every day without scalping. It is why I did the $30K challenge and doubled the account within 5 weeks without using momentum trading. To show everyone it can be done.
I get it. I get the allure. But the allure is gambling. So the next time you see an IDAF, pass it by and move on to something you can actually make some money trading.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.