The Momentum Indicator is a much simpler and more intuitive oscillator, it is used to assess the speed with which the prices of a given asset are moving.
It is an indicator of the “leading” category, that is, aimed at anticipating the possible changes of a trend in order to exploit the inversion.
As you can see, the Momentum Indicator is a line that swings around the ZERO, assuming values that can go from negative to positive.
What is the Momentum Indicator
This oscillator identifies the thrust that the various forces interacting in the market are giving to the listing of a given asset.
That is, how much they are pushing him in one direction rather than another. This becomes very important to understand the intensity of an upward or downward trend.
From a technical point of view, when we are faced with very high Momentum Indicator values or too low, we say that the asset is overbought or oversold.
We will soon see what implications this may have for our trading activity.
The Momentum Indicator is a normal oscillator that is represented with a line moving in the graph around zero.
Unlike other oscillators that in most cases move in a range between 0 and 100, the Momentum Oscillator has no limits so it can float freely around the zero lines.
Excursions far from the zero lines are not uncommon.
How to calculate the Momentum Oscillator
To do this we rely on the value that the price has assumed at two precise times.
Recommended periods for measuring Momentum Indicator on a graph range from 8 to 14.
Here is the formula for calculating the Momentum:
Momentum (t) = P(t) – P(t-x)
- Momentum (t) = Momentum value at time t
- P(t) = Price of the security at time t
- Number of observations
In practice, the difference is made between the price of today (t) and that of some time ago (t-x), divided by the number of periods it took to generate this difference.
In this way, we get the difference that we had on average for every single period. The higher it is, the more it means that the price movement was intense.
If we think in terms of trend, we can, therefore, say that very high or very low values of the momentum, indicate a considerable strength of the upward or downward trend.
How to use Momentum Indicator
The use of this indicator in trading is mainly based on the observation of this oscillator when approaching the zero line.
When the Momentum Indicator changes from negative to positive, an upward signal is generated; otherwise, when the Momentum changes from positive to negative, a downward signal will be generated.
The most commonly used periods are 10 or 14. It depends on the instrument being traded. The use of shorter periods, such as 5, may involve the high risk of obtaining false signals, with more obvious oscillations.
On the contrary, a higher number of periods traces a calmer Momentum line, which appears chamfered.
The divergences with Momentum Oscillator
Further exploitation of the values marked by this oscillator is when divergences are generated.
Usually the Momentum Oscillator “follows” the price trend, but it happens that a new maximum achieved by prices does not correspond to a new maximum marked by the indicator.
These divergences are not frequent, but when they occur the signal of a possible downward price retraction is very reliable, confirming the weakness demonstrated by the Momentum.
Obviously, the same applies in the case of new minima.
Momentum Indicator Signals
The Momentum Oscillator offers easily identifiable trading signals, both for purchase and sale.
For example, a positive momentum value indicates that the price at the end of the previous session was higher than that calculated in previous periods.
Similarly, if the momentum is negative, it indicates that the price at the end of the previous session was lower than that calculated in previous periods.
If we consider, for example, a market in which a downturn is coming to an end, the momentum oscillator will generate a purchase signal as soon as the upward movement starts.
This is possible because the last price marked is higher than in the previous period range.
Similarly, if a market in which an upturn is coming to an end, the momentum will generate a sales signal as soon as the downturn starts.
This is possible because the last price marked is lower than in the previous period range.
The zero lines represents a reference in the technical analysis with momentum Indicator.
Most analysts use the zero line to get buying signals.
In fact, many see the rise of the zero lines as a sign of purchase.
The momentum line may move horizontally despite rising or falling prices.
The explanation is very simple as it means that the price increase or decrease over the period considered has remained constant.
When there are slowdowns or accelerations, there will be a divergence (difference in direction between oscillator and prices). For example, a downward oscillator when prices are rising.
Even Momentum Indicator, although widely used, has disadvantages. In fact, there is no upper or lower band at the momentum. While most oscillators move in a horizontal band, there is no well-defined interval in the momentum. For this reason, there are no precise rules to be observed in the identification of oversold and overbought areas.
To overcome this problem, consider the “end” areas that the oscillator has touched over time and then create a path model to follow to make comparisons with the moment in which you operate.