Momentum spread trading

Momentum spread trading is a type of spread trading which aims to profit from a gathering momentum in a company’s share price. Or in fact any asset price or index value. The spread trading strategy described here is good because it is simple. The strategy uses trading tools described in the financial spread trading guide.

Which shares to trade?

In order to develop technique start to trade one subset of an index then expand to other shares, indices or assets. Here, we suggest starting with the FTSE 250.

Lets start by looking at a chart which shows all the aspects of a good momentum trade. Below is a simple price chart of Severn Trent. A water utility and not a particularly exciting company. Exciting or not, it doesn’t matter. All we are interested in is the technical aspects of it’s share price. Some call this technical analysis and it is opposed to fundamental analysis which looks are trading conditions, the economy and company accounts.

Some may have noticed that the Severn Trent is in fact a FTSE 100 company, but, it still has a great chart to show how this spread trading strategy works. Take a look. Click on the chart to open it in a separate browser window.

Chart 1

Price Chart

Look complicated? it’s really not. This strategy relies on just two indicators.

The black line is the share price The blue and green are simple daily moving averages. The graph below is one showing trading volumes.

The simple daily moving averages (which we will call moving averages) and volume are the primary indicators used to decide whether to enter a spread trade. We used ADVFN to provide the charts because they are free with their free service. Great a simple strategy with low costs.

Before selecting which company shares to trade the chart must be set up with the tools or indicators required. For those who have not used share price charts before it is a good idea to have a play around with them first. Choose any FTSE 250 company and set up a share price chart. Next add the indicators.

Select two moving averages. The moving averages are used to indicate turning points in the share price. Start by selecting a 20 day moving average and a 40 day moving average.

These time periods do not always fit the share price well. They should be seen as a starting point. The trader should expect to need to adjust the length of the moving average to fit the companies share price.

The share price show follow the short moving average as closely as possible. Shown by the share price bouncing of the line on the way up (points of price support) and hitting the line on the way down (points of price resistance).Look at the share price on the chart on the right hand side. That’s a good example.

Resistance points are where the share price is low enough to attract more buyers than sellers. As such the share price turns and starts to rise. It is the same principle for points of resistance but it works in reverse.

After becoming familiar with moving averages experiment with 20, 25 and 30 day moving averages. Start by selecting the short moving average. If the share price doesn’t fit (after experimenting with different time periods) move to another company share. After you are happy with the short moving average set up the longer moving average. Start by adding on 20 days to the short moving average to create the longer moving average and see how it looks.

In the chart above (which you can open in a separate window) it is a 20 day and 40 day moving average that are used.

What’s happening at point B on the chart. The share price increases. The average price of the last 20 days increases and so does the 20 day moving average (green). The increase in price causes the 20 day moving average to cross the 40 day moving average. STOP! This is the important bit and is one of the indicators used for the momentum spread trade.

The 20 day moving average crosses the 40 day moving average. This happens a lot and tells us nothing. On the example chart look at point B. The important characteristic here is not just that the moving averages cross, but also that both the 20 and 40 day moving average are pointing up.

The shorter and longer moving average must be pointing up. This indicates that there will be a sustained increase in share price.

This is only the first indicator. More evidence of momentum in the share price is needed. Draw the eye down to point ‘A’ on the chart. The trading volume spikes. This is generally caused by large institutional investors (pension funds, insurance companies, investment trusts) buying or selling shares. They have insider knowledge about the company and trade in advance of the information becoming public knowledge, so as to get a more favourable price.

The combination of these two indicators are a powerful tool telling the trader to trade.

The entry

In the example the cross over of moving averages should cause the trader to watch the share price closely. What the trader expects to see is a pull back in the share price. Keep borne in mind that a share price will never move in a straight line and will always exhibit some form of random price movement. Look at point ‘2’ on the chart. The price reverses and forms a point of resistance. Where buyers are not willing to pay that price and sellers rule. Draw a line across from the point of resistance. This is the level where the trader enters a trade.

The trader does not need to watch the price chart moment by moment. An order can be placed with the spread betting company to enter a trade at a pre determined price. In this example it is the price indicated by the horizontal line at ‘2’ on the chart.

After the price ‘pulls back’ it continues it’s upwards movement passes through the traders order level and the trade is opened.

Important points to consider

The order doesn’t have to be place at exactly the point of resistance (2 on the chart). The order should be set at roughly this point. Exactly where is an art and is developed with practice. In this example the order should have been placed slightly above the point of resistance. Why?

Resistance points are exactly that. Levels where there is resistance to the price increasing. What often happens is that the price tends to reverse at these points. Due to other market participants like other traders. You often see lots of repeating patterns in the share price because of self fullfilling price movements. Traders expect certain things to happen, thus making it happen!

But, the evidence here suggests that the share price won’t reverse where it did previously. This was indicated by the cross over and upward direction of moving averages. However, caution is needed because there has not be a corresponding increase in trading volume, yet (at point 2).

Without the second indicator to confirm the trade caution is needed. The order is placed slightly above the point of resistance, just in case the share price reverses at this level. Low and behold there is a massive spike in trading volume at point ‘A’. There must be many other market participants who expect an upward movement in price who have all placed similar trades. Albeit much larger trades. This confirms the trader’s suspicion that this is a good share to trade.

This example is good because it is not perfect. At point ‘2’ where the trader places an order there has not been a significant increase in trading volume.

This illustrates an important point. One indicator doesn’t always follow the other. Some trades can be duds. There could be a cross over with no spike in volume or vice versa. A cross over can still be a good reason to place an order (as in this example), but you may never get a volume spike. However, it can still be a successful trade.

Moreover, the trader shouldn’t expect any particular order to these occurrences. The volume spike can happen some time before the cross over and vice versa. One with out the other should not be seen as a sign of a good trade in isolation.

Chart 2 below shows a trade where the volume spiked first. A spike in volume is seen first (A), followed by a point of resistance and a ‘pull back’ in share price (1). Then there is a cross over of moving averages (B). So, here, the trader might place an order somewhere above the resistance point without having seen the cross over. The trader expects a cross over due to the volume spike and the characteristic pull back in share price.

Chart 2 Click to open in another window.

Momentum spread trading

What about the perfect trade?

In a perfect trade you would one indicator followed by another before the entry point. The two charts have been used to illustrate that perfect trades are not always perfect. If the trader can set up trades that don’t show perfect characteristics the trader will find more profitable trades.

What about exiting the trade?

The trader has used relatively simple indicators to enter a trade. As such, there is a simple way to exit the trade.

The trailing stop loss. A stop loss is an order is placed with the spread betting company that closes a trade (it is the reverse of a buy or sell order). A stop loss should be placed with every trade.

Use the shorter daily moving average as a guide to where to place a stop loss. Remember why the trader chooses the moving average? It is because the share price touches the daily moving average on most occasions or ‘bounces’ off it most of the time. If the share price moves down through the shorter moving average it indicates that price momentum is about to end. Point ‘2’ on Chart 2 is a good example of this.

Look at Chart 1. Points C and D are both occasions when the price hit or moved slightly below the moving average. If the stop loss is placed exactly on the moving average the trade would have been closed early. So, where to place the stop loss is kind of an art.

Take point ‘C’ on Chart 1. A share price often exhibits a large pull back like that shown at point C. To avoid closing trades early the stop loss should be placed slightly below the shorter moving average. If this area is close to a whole number place the stop loss slightly below it. Trading psychology can cause traders to enter trades at whole numbers, thus reversing the share price, forming points of resistance or support. For example, look at the 1000 pence, 1050 pence and 1100 pence levels on the chart.

As the shorter moving average moves up (or down if you have entered a sell trade) move the stop loss by the same amount. This has the effect of locking in profits or limiting losses. Never ever move your stop loss in the opposite direction to the movement in share price.

How much money to trade

Take the starting capital and divide it into 100 points. Each point has a monetary value. For example, if you have £1000 to start, each point is worth £10. If you have £100 to start, each point is worth £1. Only risk 4 points or 4% of the spread trading bank on each trade.

Multiply the monetary amount per point by 4. So, £10 per point would give £40 to trade. When placing a trade the trader has to spread bet an amount of money per point. In this case one point is a one pence movement in the share price.

To work out how much money per point to spread bet for each trade follow these instructions. Use the entry level, the price on the share price chart where the trade was entered (‘2’ on Chart 1) and subtract the number used for the stop loss. On Chart 1 this would be just below the short moving average (green line). That’s an entry at 1010 pence with a stop loss of 970 pence; 1010 minus 970 equals 40 pence.

Divide the amount being placed on the trade by the difference between the entry and stop loss to give you an amount to spread bet per point. £40 divided by 40 gives a trade of £1 per point. Follow this religiously. However, to startl the trader may wish to risk less than 4 points per trade.

How to boost profits?

After becoming confident with the mechanism of momentum spread trading the trader may want to boost returns. Take point ‘1’ on Chart 1 as an example. Along the way there will be price ‘pull backs’, which are excellent opportunities to add additional trades. Price momentum has already been confirmed. The trade is in profit. If things go wrong the trader loses only some of the profits on the original trade.


Spread trading doesn’t have to be complicated. This type of momentum trade uses two freely available indicators.

The two examples provided are both long trades, i.e. trading an upward movement in share price (using a buy order). Momentum trades work equally as well when the share price movement is down (using a sell order).

Never have more than 8 trades open at any one time. Try to reduce market risk, for example, the risk that something affects the market as a whole and moves prices either up or down. This is easy to achieve by having an equal number of buy (upward price movement) and sell trades (downward price movement) open at any one time.

There will be losing trades. The indicators will not always result in share price momentum. The stop loss limits your loses. By risking only 4% of your spread trading bank on each trade this protects you from persistent losing trades emptying the trading account.