Momentum indicators measure swings in price to and essentially look to determine whether price is overbought, where bullish momentum is overstretched, or oversold, where bearish momentum is overstretched. Momentum indicators are typically bound oscillators which means their readings fluctuate between an upper and a lower limit.
Many new traders will automatically turn to the Momentum indicator which is a default indicator on MT4 platforms. Essentially, the indicator looks at price in relation to where price has been over a specified lookback period with a view to identifying price as either overbought or oversold. The indicator oscillates around a centreline of which might or might not be shown automatically. The higher above the indicator moves; the more overbought momentum is considered to be. The further below the indicator goes; the more oversold momentum is considered to be.
The RSI indicator gives readings based on a calculation which measures the average gain of price divided by the average loss of price over a specified time. The default settings on the indicator are a 14 day lookback period and a 70 limit indicating overbought and a 30 limit indicating oversold.
The typical way that traders use these indicators can be split into two categories: The first is where traders look to fade price based on exhausted momentum when the indicator moves into extreme territory, the second is where traders look to identify divergence between the indicator and price, suggesting potential for a reversal. In the above chart you can see we have t wo examples of overstretched RSI momentum.
First you can see where the indicator has moved down to the 30 threshold suggesting momentum is overstretched to the downside, before reversing higher, and then shortly after as price moves higher you can see that the indicator moves into overbought territory suggesting that price is overstretched to the topside, before price reverses lower. This demonstrates the typical reaction that traders are anticipating when the indicator moves into extreme territory looking to buy when the momentum is oversold and sell when momentum is overbought.
In the above chart you can see a fantastic example of bearish divergence. Read more about Forex Divergence trading Price is travelling higher, putting in successive new highs suggesting that a bullish trend is likely to continue. However, looking at the RSI indicator suggests that bullish momentum is actually fading from the market. For example, in a trending environment, we would want to consider continuation signals, while in a range bound market, we would want to consider Mean Reversion type signals.
We will take a closer look at this in the later sections.
Momentum Versus Rate Of Change: Which Indicator Does The Job Better?
But for now, it is important to keep in mind, that the Momentum trading indicator provides useful information in both range bound markets , and trending market conditions. The Momentum indicator consists of a single line, however, many traders also prefer to add a secondary line on the indicator which acts to smooth the signals.
The second line is typically an X period Moving Average of the Momentum indicator. A popular setting for the X period look back is 9, 14, or Keep in mind that the shorter the X period setting is, the more noisier the signal can be, which can lead to false signals. Longer period inputs for the X setting will result in better quality signals, however, the signals will tend to occur much later. Typically, the MT4 Momentum indicator will be displayed in a separate window at the bottom of the chart panel.
Most charting software programs use momentum indicator settings of 10 or 14 for the input value. Here is the calculation for the Momentum Indicator:. Your charting program will automatically plot the output values, but it is important to understand how the calculation is done. The forex momentum oscillator helps identify the strength behind price movement. We can use momentum to pinpoint when a market is likely to continue in the direction of the main trend. In addition, the momentum study can help us to identify situations when the price action is losing steam so that we might prepare ourselves for a potential trend reversal.
The three primary signals that the Momentum indicator provides is the Line Cross, the Moving Average Cross, and the Divergence signal. We will go through each of these signal types in the following section.
Understanding and Trading with the Momentum Indicator - Forex Training Group
One type of signal provided by the Momentum Indicator is the Line Cross. When price moves from below the Line and crosses it to the upside, it indicates that prices are moving higher and that you may want to trade from the bullish side. And similarly, when price moves from above the Line and crosses it to the downside, it indicates that prices are moving lower and that you may want to trade from the bearish side. Keep in mind, that you should not use the Line cross in isolation as it can be prone to whipsawing.
The point is to keep an eye out for where price is in relation to the Line and use other filters to find the best entry opportunities. For example, in an uptrend, you may want to wait for prices to pullback to or below the line from above, and enter after price crosses back above the line. You could filter that condition with something such as a 3 bar breakout for entry. Take a look at the chart below which illustrates this:. As we noted before, you can add a second line to the Momentum Chart Indicator. The length of the moving average could be whatever the trader chooses, but a common setting is a 10, 14, or 21 period moving average.
You must have both the Momentum line and the MA line plotted in order to utilize the crossover signal. The basic idea is to buy when the momentum line crosses the Moving average from below, and sell when the momentum line crosses the Moving average from above. This by itself would be a very rudimentary application, but we can enhance these types of signals by taking trades only in the direction of the underlying trend or taking signals only after an Overbought or Oversold condition has been met.
Momentum Divergence is a very simple but powerful concept in technical analysis. A bullish divergence occurs when prices are making lower lows, but the Momentum indicator or other oscillator is making a higher lows.
On the same line of thinking, a bearish divergence occurs when prices are making a higher high, but the Momentum indicator or other oscillator is making a lower high. This dichotomy or divergence provides early clues to the trader of weakening momentum which could lead to a price retracement or a complete trend reversal.
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Momentum divergences tend to occur at market extremes where prices have pushed too far, and like a rubber band effect, it needs to revert into a value area. Divergences work well in range bound market conditions. But during strong trending markets , divergences will tend to give many false signals along the way.
The Relative Strength Index
And so, it is important not to use divergence in isolation. Understanding what is occurring on the larger time frame is often very helpful in filtering out low probability trades. Looking for key support and resistance areas and using that as a backdrop to lean on a divergence setup can increase your odds of a winning trade substantially.
During a trending market condition, you can also look for a pullback where price action is diverging from the Momentum indicator. A divergence trade setup that is aligned with the overall trend is likely to provide a higher success rate, than bucking a strong trend and trying to pick a top or bottom.
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When attempting a counter trend trade with momentum divergence, it is important that you have additional evidence that a trend reversal is likely. No matter how far a market has extended or how good a counter trend divergence signal looks, it could very well be a false signal, and the market could continue to trend. The first example below occurs within a range bound market. A sell signal is generated, when the indicator climbs above the overbought level and then moves back below it. Chart Source: VT Trader. Skip to content « McGinley Dynamic.
Percentage Price Oscillator ». Momentum This lesson will cover the following Explanation and calculation How to interpret this indicator Trading signals, generated by the indicator. Lot Size. Fusion Markets Lowest trading costs. Ava Trade.