The goal of momentum trading player is to buy strength or sell weakness. In systems trading, this is exemplified by breakout models, which buy when prices move above, or sell when they move below, some threshold. The idea is to buy into movement that is expected to continue long enough to make a profit. Grabbing profits as a momentum trader involves jumping onto a developing trend quickly and then jumping off before the trend dissipates.
An advantage of momentum trading is that you know the market is strong and moving in your favor at the time of entry. Assuming that the movement persists, you are assured of a profit, that is, if you exit before the trend reverses. Frequently, the profit can be substantial. A problem, however you are likely to encounter large amounts of slippage or get on board too late in the course of a move.
A disadvantage of momentum trading is that you generally cannot work the market using limit orders as a means of eliminating slippage and reducing costs when entering positions. Using a limit order is like trying to jump aboard a fast-moving train as it speeds away from you. Limit orders at prices you like are unlikely to be filled, since the option or future is moving beyond the limit too quickly. Without any hesitations or retracements, the price you have set in your limit order will never be hit. For exiting momentum trades, however, limit orders can be used effectively. Even so, you must be careful when using limit orders to exit - you may cut very large profits short. Some thrusts or bursts of momentum can carry a market very far. You don't want to jump off too early, before the movements begins to slow, and missing out on a continuing trend that could yield additional profit.
The specific inefficiency that the momentum trader tries to capture is the tendency for market movements to persists. In a totally efficient market, predictable persistence of movement would not exist. However, this is one of the ways in which real markets are frequently inefficient. In the terms of statistics, a positive serial correlation exists between successive returns.
In momentum trading, it is important to exit before the move is completely over. There should still be a sufficient number of traders to take the opposite side of your trade, that is, to buy what you are selling. If you exit at the appropriate time, slippage should work in your favor, not against you, even with a market order.
