Understanding momentum indicators in trading is crucial. Not only is it important in that it can ensure that the trade decisions you make will handsomely reward you, but when you understand these indicators, you will also be able to minimise your risks, to a degree.
If you have been a student of technical analysis for a while, you will understand why momentum indicators are considered one of the more important concepts.
Traders use momentum indicators on an almost daily basis to read the strength of price movement as it is displayed on a price chart. Generally, the indicator is identified by a momentum line on the chart.
In industry terms, the momentum indicator is referred to as an oscillator indicator. This is because the line moves between the 100 centreline, which is, in some cases, displayed. The indicator is also called a leading indicator. This means it has the ability to predict trends before they become obvious.
And this is exactly why every trader needs to understand how to read and interpret the indicator.
When traders look to the momentum indicator, they are looking for information about the rate of change (otherwise referred to as the speed) at which the price movement shifts. It is designed to measure the most recent closing bar and the previous closing bars. A period of closings is then compared to determine a possible trend.
The overall analysis will tell the trader exactly when the price movement gains or loses momentum.
When the trend shows a loss in growth, that it is losing momentum, it tells the trader that the market is exhausted and that a reversal is imminent. When the opposite is true, the trader can see that the trend is stable and strong, and will possibly continue to grow in strength.
Momentum Indicator Trade Signals
Trade signals are the lifeblood of all traders. Without them, even the most experienced trader will be left in the dark when it comes to their trade decisions. These signals will almost always be provided by a specific type of software, but traders have to be able to actually make sense of the lines and graphs.
Even when a trader has a gut feeling on something, the trade signals will become their much-needed confirmation.
How to read trading use on a graph
100 Line Cross
The average buy or sell signal is represented by the price crossing either above the 100 Line or below it. Sometimes the 100 Line is represented by a 0.
When the price rises above the 100 Line, it tells the trader that the price is gaining strength. And when it drops below the 100 Line, it tells the trader that the price is losing its speed.
Unsurprisingly, the 100 Line Cross is prone to rising and falling within moments. Just like most of the trade world, trends can come and go in an instant. What was once a sure thing can quickly become a less profitable choice. Sometimes, it is best to view signals based on what is currently trending.
Divergence happens when the price moves quite low but the lows as indicated on the momentum indicator are moving up. This means that although the price is definitely dropping, momentum behind the drop is slowing down. While viewing this, if the buy signal is indicated, the Divergence will help to confirm what you are seeing. This is called Bullish Divergence.
When the opposite happens, and the price is moving higher, but the highs on the indicator are dropping lower, there is what is called a bearish divergence. Breaking it down, this trend will indicate that although the price rises, the buying speed is slowing down.
It is best that when you are using Divergence, you use another form of trading signal alongside it.
A moving average line is what determines this signal. By adding a moving average to the indicator, before buying or selling while looking at a Crossover, the moving average will indicate the closing price over a number of days.
Traders will then buy when the momentum indicator crosses over the line, but only when it moves from average to below the line, and it will indicate a time to sell with the indicator moves from average to above.
Much like the other indicators mentioned, there are, of course, problems with this one as well. Like the 100 Line Cross tactic, there is an issue with the prices fluctuating rapidly and no longer being viable. You can divert trading catastrophe, by only banking on the direction of the trends you are presented with. This is what most traders would do.
When using the momentum indicator while trading Forex, traders both new and old will find that the indicator is incredibly versatile and will provide a variety of helpful uses. Not only does it easily fulfil its role as a trend confirmation signal, but it will also be ideal for those looking for a trend reversal signal.
What else should a beginner know?
You should learn how to calculate the momentum indicator.
As we mentioned, the indicator is made to compare the closing price of today with a closing period as indicated by “n” periods, as shown on the charts.
The “n” signals an input value which has to be determined by you, the trader. The software programme you choose to use will almost always use a setting of 10 or 14 as the input value. The “n” will set the period of time that you want to compare. So if you use 10, the period will calculate the closing price input of 10 years and compare it to the current value.
Now that you are more informed about momentum indicators and how they can transform your approach to trading, you can fully benefit from the information that you can glean from a price chart.
As a trader, you already know that this is not enough information to make sure that your trades are well-placed, so make sure you continue to read up as much as you possibly can about this fascinating industry.
Frequently Asked Questions
What is momentum in forex?
In short it is the overall rate of change in the price of an asset.
What is the best momentum indicator for Forex?
Relative Strength Index (RSI), the Stochastic oscillator and the Moving Average Convergence Divergence (MACD).
Which forex indicator is most profitable?
The Ichimoku Kinko Hyo
What is the most powerful indicator in forex?
(MACD) Moving Average Convergence/Divergence.
What are the best indictors to trade with in MT4?
Bollinger Bands / Money Flow Index / RSI / Stochastics / MACD