What is Riding the Wave in Trading?

If you have ever sought trading advice, you may have heard the adage “riding the wave” or “trading with the trend”. Often traders tend to follow the market instead of taking a contrarian strategy. This is because market trends follow certain patterns that traders can identify and capitalise on. Moreover, it provides traders with higher chances of success.

In the following sections, we will provide a detailed overview of riding the wave trading strategy, how it works, and other important strategies. 

Understanding Riding the Wave Trading Strategy

Riding the wave is capitalising on the wave of market sentiments to make profits. It’s essentially momentum and trend-based trading. Momentum and trend trading works on the principle that strong price movements driven by increasing volume will continue in the same direction for a certain period. Traders capitalise on the continuation of a trend by trading in the same direction. 

When a security is trending upward, trend-based traders enter into long positions. When the security price is tending downward, these traders take short positions. Thus, this trading strategy involves following market trends to make profits as long as they continue and exit before a reversal. Trend-based trading is easy and straightforward. However, traders must take the necessary precautions. 

How Does Riding the Wave Strategy Work in Trading?

The stock market is an unpredictable place with sudden ups and downs that can make even the most seasoned traders uneasy. Therefore, many traders take a strategic 'riding the wave' approach in the market, trading short or long with trends and exiting when these trends die out. 

The main principle behind such momentum/trend trading is that strong price movements tend to continue for a while in the same direction. Traders take positions only when they see clear signs of an upcoming price movement. They often create 'take profit' and 'stop loss' orders to ensure they lock in their profits and avoid substantial losses in case the market moves in the opposite direction. 

Momentum traders rely on price action and technical indicators to determine the trend direction. When the price moves above recent highs but does not drop below prior swing lows, that is a sign of an upcoming uptrend. For a downtrend, the price makes lower lows and lower highs. Traders must be aware of the high risks of such predictions as they may not come true.   

How to Ride the Waves Using Momentum Trading?

Follow the simple process given below to make profits with momentum trading:

1. Identifying the Right Stocks: The key to successful trades lies in selecting the right stocks that are going to experience significant price movements. This can be driven by market sentiments, earnings reports or news events.  
2. Wait for a Confirmation Signal: Momentum traders must be patient and wait for a clearly identifiable trading signal before taking any action. This could be a breakout from a key resistance level, a chart pattern or a pullback to support. 
3. Determine the Position Sizing: For effective position management, you should consider multiple factors such as spreads between bid and ask prices, holding periods, etc. Avoid putting too much cash on a single trade. 
4. Identifying Exit Points: As a disciplined trader, you must set a clear profit target to exit your trade. Moreover, you must set a stop-loss order to limit your potential losses. You can find ideal exit points by analysing price charts and technical indicators like moving averages, momentum indicators, etc.  

Riding the Wave or Momentum Trading Strategies

Here are some of the popular momentum trading strategies:

• Cross-sectional Momentum Strategy: These strategies compare the performance of stocks relative to each other in a portfolio or within the same category. Traders buy top-performing stocks while selling the underperformers. 
• Time-series Momentum Strategy: Here, traders assess the performance of a group of stocks over a specific period and invest in those which have crossed a threshold performance level. The performance of each stock is compared to its historical performance.  
• Breakout Trading Strategy: In this strategy, traders aim to identify stocks whose prices are showing signs of breaching key support or resistance levels. 
• Moving Average Crossovers: Here, traders compare moving averages of different periods to get buy or sell signals. They use a crossover of short-term and long-term moving averages to understand if the momentum will change or not. 
• Relative Strength Index Strategy: This involves the use of the Relative Strength Index (RSI), a momentum indicator that provides buy and sell signals. This indicator provides a value between 0 and 100 to indicate overbought or oversold conditions. Traders use this tool to get clear ideas of market trends and open and close positions accordingly. 

Conclusion

Riding the wave is a trading strategy that involves closely following the price movements of a stock and taking positions when you find clear patterns that confirm a new trend. While it works most of the time, the market can be unpredictable, leading to losses. As a momentum trader, you will want to take a strategic approach, ensuring that losses are limited and profits are made on most trades.

Disclaimer: This content is solely for educational purposes. The securities/investments quoted here are not recommendatory.