What Are Momentum Indicators & How To Trade Them

Momentum indicators are a type of technical indicator that can be used to help try and determine an asset’s price or weakness. A momentum indicator (oscillator) shows the trend direction and measures the pace of the price fluctuation by comparing current and past values. It is one of the leading indicators that measure the rate of change of securities. A momentum trading strategy is when investors buy securities that are rising and sell them when they look to have peaked. The goal is to work with volatility by finding buying opportunities in short-term uptrends and then sell when the securities start to lose momentum.

What are the Momentum indicators?

In Physics, the term Momentum refers to a moving object. Similarly, in financial markets, Momentum is the movement of an asset’s price. It measures upward or downward price fluctuations.

Most of the indicators that measure Momentum use specific values to suggest an overbought or oversold condition. When the asset is overbought, this means there is an intense buying pressure and signals a price decline. On the other hand, when the asset is oversold, there is a strong selling pressure, and it’s an indication of an upward movement.

The Momentum indicators show price fluctuations between a range. This means that these indicators are bound by values that are between 0 and 100. When the price rises or falls between these values, the Momentum indicators provide buy or sell signals.

When considering market trends, Momentum indicators are an essential part of the analysis, as they measure the trend’s strengths and weakness, and tells traders about future movements.

According to historical analysis, the Momentum indicators work best when the market is rising rather than falling markets.

Some of the common Momentum indicators are:

1. MACD (moving average convergence divergence)

The MACD utilizes two moving averages to measure the price movements. It is calculated by subtracting the 26-month EMA (exponential moving average) from the 12-month EMA. With these calculations, the MACD line along with 9-day MACD plots on the chart. It is also known as the signal line.

The central line act as a guiding force for traders. When the price drops below the zero-line, it’s a sell signal, and when the price rises above the zero-line, it’s a buy signal.

MACD on a chart
MACD on a chart

2. Relative Strength Index (RSI)

The RSI measures the size of recent price movements. The RSI calculates by looking at the average profits and losses over a 14-day period. It ranges between 0 and 100 to provide overbought and oversold conditions.

If the price value is above 70, it’s an overbought condition, and traders must be prepared for a price reversal. Whereas, if the value is below 30, it’s an oversold condition, and there would be an increase in price in the future. 50 is considered a neutral level, and traders may wait for the price to fall or rise, and then take positions.

RSI on a chart
RSI on a chart


3. Stochastic Oscillator

The Stochastic Oscillator compares the closing price of an asset with the historical prices over a specific period.

Like the RSI, it generates overbought and oversold trading signals between 0 and 100.  Values over 80 are overbought, and values below 20 are oversold. While the RSI shows only one line, the Stochastics displays two lines, a signal line, and a trend line.

The Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a set number of periods. The closing price tends to close near the high in an uptrend and near the low in a downtrend.

Stochastics on a chart
Stochastics on a chart


4. Rate of Change

The rate of change or ROC, gauges the speed at which is the speed at which price changes over a specific period.

The ROC illustrates a single slope of a line that uses a percentage value over a certain period to define price movements. The ROC fluctuates between 0.84 to -1.29.

An asset with the high Momentum has a positive ROC, and it’s an indication of a buy signal. In contrast, an asset with low Momentum has a negative ROC and is a sell signal.

ROC on a chart
ROC on a chart

How to use the Momentum indicators?

Traders can use all of the above-mentioned indicators as part of their trading strategy. Momentum indicators do mention entry and exit points, so traders would not find them difficult. However, they are only as a guide and not set in stone. So, how can you incorporate a Momentum Indicator strategy into your Forex trading? Whilst the Momentum Indicator can be used to provide trading signals, it is better used as a confirmation tool for signals generated by either price action or other technical indicators.

Momentum traders will seek to identify how strong the trend is in a given direction, then open a position to take advantage of the expected price change and close the position when the trend starts to lose its strength. A momentum trader doesn’t necessarily attempt to find the top and bottom of a trend, but instead focuses on the main body of the price move. They aim to exploit market sentiment and herding – the tendency for traders to follow the majority.

Momentum Indicators conclusion

Momentum indicators are tools utilized by traders to get a better understanding of the speed or rate at which the price of a security changes. Momentum indicators are best used with other indicators and tools because they don’t work to identify the direction of movement, only the timeframe in which the price change is occurring.

Momentum Indicators can be used on your trading platform charts to help filter potential trading signals as part of an overall trading strategy. Momentum Indicators can help determine the trend’s strength or weakness. As no indicator is 100 percent accurate, traders can choose to combine these indicators with other technical analysis forms to filter trading signals accordingly.

It is more common to utilize them with other technical indicators that reveal the directions of trends. Once a direction’s been determined, momentum indicators are valuable because they indicate the strength of price movement trends and when they are coming to an end.

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