What is Momentum?
Momentum within technical analysis, is a method for describing the rate of change of an underlying asset. This shows us how quickly or slowly a price may be changing which you obviously want to know if you are trading that market and are trying to predict what might happen going forward. Momentum is usually plotted as an oscillator indicator which measures the rate of change in prices over a period of time. A momentum indicator always lags the price, so if the price of an asset rises, the momentum indicator increases and if the price decreases, the momentum indicator falls. The same is true conversely, so, if rising prices start to slow, the momentum indicator will also begin to decrease, and prices rising quicker will trigger an increase in the indicator. However, the indicator will always be slightly behind the price action as it needs this data as part of the its own calculation (as we are sure you have noticed with many of the indicators).
You can easily calculate the momentum indicator by applying the following formula:
- Set up a reference period (default is 14)
- Divide the current closing price by the closing price of the 14th bar.
- Multiply the result by 100 and you will get one of the Momentum indicator’s values.
- To add additional values of the Momentum indicator, you simply need to continue calculating with new closing prices by using the same method above. It’s that simple!
The Momentum indicator can also act as a trading ‘signal’. For example, if it reaches the upper area of the indicator’s chart and starts decreasing, you might expect a reversal, potentially indicating a sell signal. When the momentum indicator has bottomed and then starts to rise, you may view it as a potential buy order. However, we highly suggest that, as with all indicators, you consider using another tool in addition to identify the trend direction.
It can be very useful to know how quickly or slowly a market is moving and the Momentum indicator allows you to visualise this. It is always better to ideally be in a position just before a rapid period of movement. Likewise if a market has lost the initiative and may now start to move sideways for an extended period, you may feel like you are better off closing your position and moving onto the next opportunity. Therefore, we believe that the Momentum indicator can offer valuable insights that other indicators don’t.