What Are Momentum Indicators & How To Trade Them

Momentum Indicators

Momentum indicators are a type of technical indicator that can be used to help try and determine an asset’s price or weakness.

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

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.

Momentum Indicators conclusion

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.

I would prefer to use the majority of market analysis such as Momentum Indicators on the 1-hour charts and above. I tend to find that these charts contain less market noise than the lower time frames and thus give more reliable signals for my forex trading strategies. This also means that I spend less time staring at charts and can also set alert notifications to let me know when price has reached certain levels, candlestick pattern has been formed or a particular indicator value has been reached.

Momentum Indicators are just one method of market analysis amongst thousands. I would not build a trading system alone, but rather combine with other technical indicators such as moving averages, Parabolic SAR, Stochastic Oscillator, RSI, ADX and price action analysis.

Of course, every trading system will generate false signals which is why money management is so important. I would personally be implementing sensible money management and only take traders that give me a favorable risk to reward ratio, ideally of at least 1:3. This means that one losing trade does not wipe out consecutive winners.

The methods of implementing Momentum Indicators 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 Momentum Indicators, 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!