What Is The Momentum Indicator & How To Trade With It

Momentum Indicator Explained

In this article, we will discuss the momentum oscillator, which some traders well argue is as effective as its more well-known counterparts. The momentum indicator builds a curve that fluctuates wither side of the midline which is set to 100 by default.

What is the forex Momentum indicator?

Like the RSI and Stochastic, the forex momentum indicator can help determine when overbought or oversold conditions occur in the market. That is, to show whether sufficient momentum remains behind the trend to support the price movement. When a falling market is oversold, it can reverse sharply, and the trend may go up. When a rising market is overbought, it may fall.

The momentum indicator is one of the standard indicators available in the standard versions of the popular MT4 and MT5 platforms that you can download for free from most forex brokers. The calculation of the momentum indicator is quite simple.

The indicator works by comparing certain price with a previous price for a specific number of periods. The first step is to select a value for N, that is, the number of periods to be used for comparison.

The default value for this indicator for N is 14, but you can set any value as you wish. Two comparable prices are the closing price of the current bar and the previous closing price of N bars. The formula for momentum is as follows:

Momentum = (current close / close N periods ago) x 100

The good news is that MT4 and MT5 perform calculations instantly and display them for you in an additional window below your main chart.

Here’s what the Momentum indicator looks like on a chart:

Momentum indicator on chart
Momentum indicator on chart

On the hourly chart of EUR/USD above, you can see that a momentum indicator has been added, which is displayed as a blue line in separate window. The peaks and troughs of this line reflect key shifts in the momentum of the price.

Using the Momentum indicator

Typically, technical indicators are used as a means of confirming signals along with additional market analysis. Thus, your buy or sell signal will come from a combination of analysis whilst the momentum indicator can be used as a means to measure trend direction. One of the best momentum indicator methods is to look for the discrepancy between price and momentum, as a way to measure the force behind the movement.

As we have seen, the momentum indicator is a useful tool with a wide range of applications. The same tool can be used as an indicator of stock momentum and as an indicator of Forex momentum. You can apply it to any trading instrument across a variety of asset classes provided by your trading broker.

The versatility of the indicator also means that you can easily create impulse trading systems that work both in the short and long term. As a rule, the shorter the time frame for the pulse indicator, the more sensitive the performance will be.

This is because it can generate more false signals compared to a more extended period. I prefer to use longer time frame charts such as the 1-hour and above as I find this can help filter out some noise from the lower chart time frames. That being said, the momentum indicator can be a useful trading tool for day trading or swing trading.

As we mentioned earlier, the technical indicator Momentum is one of several trend generators available in MT4 and MT5. It is worth noting that there are other momentum indicators, such as the MT4 Stochastic Momentum Index (SMI). Still, you will have to load them as custom indicators if you are interested although the standard momentum indicator is just as effective in my humble opinion.

Forex Momentum strategies

The strategy suitable for the momentum indicator can differ depending on your trading style and goals. You can use the Indicator to directly provide trading signals, but it is more often used as a confirmation tool.

The most straightforward signal is to look for price to cross the midline, buying when the value rises from below 100 to above and selling when it falls below 100 from above. I would certainly add additional analysis to confirm these signals such as moving averages to help determine the overall trend.

Moving average with the Momentum indicator

Some traders prefer to smooth the momentum curve using a simple moving average (SMA). You can do this by clicking the Moving Average in the Trend Indicators list in MT4, and then dragging it onto the Momentum indicator chart. This will bring up a typical dialog box. In the “Parameters” section, select “First indicator data” from the “Apply to” drop-down menu, as shown below:

Moving average with momentum indicator
Moving average with momentum indicator

The trading strategy is now changing, as a result of which the trader may look to buy when the momentum line crosses the SMA, and sell when it crosses the SMA. This should slightly improve the timing of the signal, but still has the disadvantage of offering a lot of false signals.

Momentum indicator strategy
Momentum indicator strategy

Look at the chart above. As the momentum line crosses moving average and is above the 100 level, you can buy the asset. Stop loss could be slightly below the swing area and profit level I would want to be 2 to 3 times the stop loss, giving a favourable risk to reward ratio. Similarly, you can sell an asset if the momentum indicator crosses below the moving average and below the 100 midline. Stop loss in this instance could be slightly above the swing area whilst the profit target I would again aim to place at least 2 to 3 times the size of the stop loss away from entry.

The momentum indicator can also be used to help identify price divergence and overbought/oversold areas. The further away the momentum line is from the 100 middle line, the more likley it could be that the market is going to eventually reverse. This can be confirmed with other trading indicators such as the ADX and RSI.

Momentum indicator conclusion

The momentum indicator is primarily used as a confirmation tool rather than a main indicator. However, the momentum indicator along with a moving average can be used as a very basic forex trading strategy.

The methods of implementing the Momentum indicator into a trading strategy that are outlined within this article are just ideas. I would always ensure that I have good money management, trading discipline and a trading plan when using any forex strategy.

Furthermore, I would combine multiple technical analysis, fundamental analysis, price action analysis and sentiment analysis to filter all entries. You should trade forex in a way that suits your own individual style, needs and goals.

If you would like to practice trading with the Momentum indicator, you can open an account with a forex broker and download a trading platform. If you are looking for a forex broker, you may wish to view my best forex brokers for some inspiration.

Happy trading!