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What is the momentum indicator?

What is the momentum indicator?

Hi and welcome aboard! Today we’re going to discuss the momentum indicator – an important part of technical analysis. In previous articles, we’ve already talked about basic terms in technical analysis and gave you a taste of the RSI index, which is closely related to momentum. Now, it’s time for us to look deeper into momentum and figure out how some traders use it when making decisions.

Are you ready to get started? You better be, because here we go…

The momentum indicator defined

Let’s begin by explaining the concept of ‘momentum’. Momentum is the speed or force of movement. In trading, momentum is the rate of acceleration of an instrument's price or volume. Confused? In simpler words: How fast the price or the volume is increasing. In technical analysis, momentum is commonly used to identify trend lines. It’s viewed as an oscillator. What’s that? We’re just getting to it.

The momentum indicator defined
A quick chat about oscillators
In case you haven’t read our RSI article (and if that’s the case you should, it’s awesome), here’s a quick explanation about oscillators. Oscillators are technical analysis indicators that move within a band over time. Their movement occurs in one of two ways:
  1. Above and below a single center line
  2. Between two specific levels
Oscillators are seen as indicating short-term oversold or overbought instruments.
Got it? Great. Let’s continue.
Short term vs. long term momentum

Short term vs. long term momentum

If you wonder whether momentum is a short term or a long term trading strategy, the answer is very clear: Momentum is - at least commonly - used in short term trading. This makes sense if you think about it: The point of momentum trading is to buy high and to sell even higher (or vice-a-versa if you’re short trading). It tries to benefit from the time gap that exists before reversals take place. Since the point is to take advantage of a trend while it’s ‘hot’, this is traditionally a short term to intermediate term strategy.

Feel like we’re going too fast? Go over the basics by reviewing our Technical Analysis for Beginners.
Momentum Formula

Momentum Formula

Before we begin with calculations, let us make one thing clear:
You will never need to actually calculate momentum – unless you want to.
The iFOREX platform includes a momentum indicator and we’ll explain where to find it shortly. However, if you want to know the calculations, the formula really isn’t all that complicated.

For example, in order to create a 10-day momentum line, simply take the last closing price and subtract the closing price from 10 days ago. The result will be a positive or negative value, which can be placed around a zero line.

And now, the formula: M = V - Vx

What does it mean? V is the latest price and Vx is the closing price x days ago.
Got it? Great. Didn’t get it? Don’t worry about it. You can simply use the automatic momentum tool at the click of the mouse.

Good to know:
Historically, momentum is more useful when markets are rising than when markets are falling.

Finding the momentum indicator on the iFOREX platform

We promised you could find an automatic momentum indicator on the iFOREX platform and we’re going to deliver. If you are on the ‘charts’ section of the iFOREX trading platform, simply click on the ‘Indicator Wizard’, choose oscillators (because – as we said – momentum is an oscillator) and then add ‘Momentum’.
You can also add the indicator directly on the chart appearing on your deal slip.

Here is what the momentum indicator looks like when overlaid on a standard chart:

momentum indicator

Momentum and the ROC indicator

Rate of change (ROC) is a valuable technical indicator of momentum. Its aim is to measure the percent change in price from one period to another. As the ROC moves from positive to negative, it fluctuates above and below the zero line. When used as a momentum oscillator, ROC can be viewed as offering signals on divergence, centerline crossovers and – of course – when an instrument is overbought or oversold.

For example, if the price of an instrument closes higher today than it did 10 days ago, the ROC value point will be above the center line, indicating that prices are rising. If the price of the instrument closes lower today than it did 10 trading days ago, the value point will be below the centerline, indicating that prices are falling. A rising ROC could indicate a short term bullish signal, and a falling ROC could indicate a short term bearish signal.

Remember: Timeframe is crucial when dealing with ROC.

ROC indicator What is momentum indicator?

How to measure momentum using RSI

The RSI, AKA the Relative Strength Index, attempts to measure momentum by comparing higher closes and lower closes. Usually, the RSI is used on a 14-day timeframe. If a specific instrument has more – or stronger - positive changes, it will have a higher RSI than an instrument that had more - or stronger - negative changes.

RSI has a scale of 0 to 100. The 70 line is viewed as a high level and 30 as low. If the level is higher or lower – 80 and 90 or 20 and 10 – it could indicate a much stronger momentum.

Here’s an example of what the RSI looks on a standard chart…

How to measure momentum using RSI

This is just the tip of the iceberg of course. If you want to know more about this fascinating indicator, check out our in-depth RSI page.

How to measure momentum using MACD

MACD (Moving Average Convergence/Divergence) is a technical indicator aimed at unveiling changes in a trend’s momentum – but not just momentum – also direction, duration and strength. MACD displays the relationship between two moving averages of instrument prices.

Here’s an example of what the MACD looks like on the iFOREX platform:

MACD (Moving Average Convergence/Divergence)

Do you now know enough to start using MACD? Far from it, but if you drop by our MACD page, you can learn more.

How to measure momentum using a Double Bollinger Band

You probably heard about Bollinger Bands, but did you know that there is also a variation called Double Bollinger Bands? Essentially, these are two sets of regular Bollinger Bands.

Don’t know who Bollinger was and how his bands are used by traders? Our Bollinger Bands page covers this topic in depth. You already know your basics? Great, let’s move on.

There are several reasons for why some traders use double - rather than classic - Bollinger Bands. One is that ‘doubles’ can offer a lot more information regarding momentum.

How do you compose Double Bollinger Bands? Simply place a standard Bollinger Band with a setting at the 20-day moving average with a standard deviation of 1. Then add another Bollinger Band with a standard deviation of 2. Both are placed over the same time period, creating a spread between the bands. This - in theory - offers stop-losses and profit targets.

How to measure momentum using a Double Bollinger Band

Now we know, using the term ‘simply’ was perhaps somewhat of an overreach, but in truth, once you get the hang of the Double Bollinger, you will see it’s not all that different than using standard Bollinger Bands – all it takes is some practice.

Now, let’s get back to our ‘Double’. The spread between the standard deviations offers indications of entry and exit points. For example, a cross above the first standard deviation is viewed as a buy signal (the profit target is at the second standard deviation and the stop-loss is the first standard deviation). What happens when you see a cross below the first standard deviation? This is viewed as a short signal (the profit target is located at the lower band of the standard deviation and a break back above the first standard deviation is seen as the stop-loss).

Note: Traders sometimes alter the number of standard deviations as well as the duration and type of the moving average.

If you are confused, we don’t blame you – this is a lot to take in. Even if you are a well-seasoned trader, there is really no way of covering the whole concept of Double Bollinger Bands in a couple of paragraphs. If you want to master this theory and get a better insight of how it works in practice, you will need to do some additional reading.

Using momentum while managing risk
Momentum markets can be extremely tempting – especially for novice traders. Momentum trading is pretty straightforward: Buy high - sell higher, and it’s easy to get caught in the excitement and forget that this type of trading also involves high levels of risk. Momentum trading requires strict rules, discipline and - most importantly - solid risk management techniques.

You need to choose the right instrument. By ‘right’ we mean instruments where movement tracks the underlying instruments, so you’re not misled by false signals.

You also need great timing since, as with any type of deal, the crucial decision is determining entry and exit points. Trading momentum with other indicators such as MACD for example, can be useful in identifying these points.

Finally, you need to try to control your emotions and to stay calm while you’re riding the trend. We know it’s easier said than done. It’s easy to lose yourself in the thrill of the momentum. However, in order to better manage risk, you need to locate the entry and exit points and remember your strategy.

To view our full list of tradable CFD instruments, visit our Trading Conditions page.
Momentum buy & sell signals
Momentum buy & sell signals

In theory, the momentum indicator can be used as indication of trade signals. Here are some examples:

  • 1 100 Line Cross - When the instrument’s price crosses above or below the 100 line, it can be viewed as a buy or sell signal respectively. However, the problem in this case is timing, since by this point most of the change had already occurred.
  • 2 Crossover – When adding a moving average to the momentum indicator, crossovers can be used as useful indications, supporting signals. What do we mean? When the Momentum indicator crosses above the moving average, it’s viewed as a Buy signal and when it crosses below, it’s viewed as a Sell signal. The problem with this strategy is lots of signals but few decent trading opportunities.
  • 3 Divergence – When the instrument’s price is moving lower, but the momentum indicator’s ‘lows’ are on their way up, this can be viewed as a ‘bullish divergence’, potentially helping you confirm a Buy signal. If the price is moving higher, but the momentum indicator’s ‘highs’ are moving lower, this can be viewed as a ‘bearish divergence’, potentially helping you confirm a Sell signal.

These are just examples of course. As we’ve explained above, in many cases traders will not use momentum on its own, but alongside additional indicators and strategies.

Remember: While momentum is at the heart of many trades, it’s not without its shortcomings and just like any strategy, it will not always work effectively – or work at all.

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