Thursday, 27 June 2019

How to Use the Momentum Indicator

The Momentum indicator measures the speed and magnitude of price changes in a given period of time. In general, the momentum indicator will rise when the trend direction is strong, and vice versa will decrease when the trend is weakening. In this article, we will review the use of the original momentum indicators, not derivatives such as the Commodity Channel Index (CCI), Relative Strength Index (RSI), or stochastics.

The Momentum indicator is also commonly called the Rate of Change (ROC). Momentum is measured for a certain period of time with the formula:

Momentum at time period n = (current closing price / closing price at period n) x 100

The time period n by default that is often used is 14.

In general there are 3 ways to use momentum indicators, namely: as a trend following indicator, as a trend reversal indicator and as a leading indicator with signs of divergence occurring.

1. Determine the direction of the trend with momentum indicators
In the Metatrader trading platform, momentum indicators use level 100 as a reference.

2. As an indicator of continuation of trend direction or trend reversal
In this case the momentum indicator can show overbought and oversold levels like the RSI or stochastic, but because the overbought and oversold level zones cannot be determined (relative), we must pay attention to extreme conditions with certain assumptions. If the momentum indicator reaches the highest or lowest level (relative), we must assume the direction of the trend will continue as before until the price movement changes.

For example if the momentum indicator reaches the highest level and then goes down then we assume the price will still go up, and we will only enter a sell entry if the price has actually dropped. To be safe, it can also be confirmed by the moving average indicator.

3. Seeing the signal of divergence between price movements and direction of movement of the momentum indicator
The following examples are the occurrence of bullish divergences (blue lines) and bearish divergences (red lines).

Also Read :  Strategy Using Alligator Indicators

Bullish divergence which indicates a trend reversal (from bearish to bullish) is if the price movement shows a lower level lower than before (lower low), while the momentum indicator shows a low level higher than the previous low (higher low).

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