Momentum indicator - what you need to know
Among all the indicators used for technical analysis of the market, Momentum is at the same time one of the most popular and simple. It shows the average rate of price change over a selected period of time. At its core, Momentum is a leading indicator in relation to the current market movement. This means that prices on the chart can still rise, and the instrument will already “draw” the top and begin to fall, only after which a change in quotes will follow in a downward direction. Today we’ll talk about how the Momentum indicator works, non-standard trading strategies for it, and important nuances.
Currency pairs: any
Trading time: around the clock
Recommended brokers: Alpari, RoboForex, InstaForex
What is this indicator?
This indicator was created by the talented French mathematician Paul Emile Appel, who is the father of many ingenious technical devices and the author of more than a hundred books and articles on analysis, geometry and mechanics.
Appel was born on September 27, 1855 in Strasbourg. In 1873 he entered the Higher Normal School in Paris. In 1876 he received a doctorate in mathematics, defending a thesis. In 1885, he was appointed professor at the Department of Rational Mechanics at the University of Paris. In 1892 he was elected a member of the French Academy of Sciences. In 1911 he became a corresponding member of the St. Petersburg Academy of Sciences, in 1925 he was elected a foreign honorary member of the Russian Academy of Sciences. By the way, the asteroid Appella, discovered in 1922, is named after Appel.
The Momentum indicator is perhaps the simplest and most understandable of all trend indicators. To find out if a child is growing fast enough, you can measure his height every month and compare it with growth six months ago. Then you will find out whether your child is growing normally, whether he is so behind that he needs to be taken to a doctor or is growing so fast that you need to think about a basketball coach. The momentum shows you: whether the trend is accelerating or slowing down, or maybe it keeps its speed.
When the momentum reaches a new maximum, this suggests that the optimism of the market crowd is growing, and the rise is likely to continue. When the momentum drops to a new low, this indicates an increase in the pessimism of the crowd and the likelihood of a continued fall in prices in the future.
When prices rise and momentum falls, it warns you that the peak is close and it is time to profit from held positions and tighten stops. When prices give a new high, and the maximum of the momentum is lower than the previous one, the divergence of the bears gives a strong signal to sell. The opposite is true for a downtrend.
Sometimes a smoothed Momentum indicator is used, which reduces volatility through the use of moving averages.
The popularity of the indicator is primarily due to its simplicity, versatility and the fact that it is one of the few leading indicators. Momentum not only responds to the direction of price movement, but also changes direction before it is done by prices. As a rule, at the beginning, the indicator reverses with the continuation of price growth, and only then the trend reaches the top and turns down. If the indicator starts to fall more slowly and then turns up, then soon the trend will also reach a minimum and reverse.
Here, however, it is worth emphasizing that all oscillatory methods are designed to trade in the direction of the prevailing trend, which is more important than any signal. In a pronounced bull or bear market, you can use only those signals that call for buying or selling, respectively.
Installation and settings
Of the settings, the indicator has only an averaging period. You can also select a price to calculate and set levels. By default, level 100 is already set - it serves as a zero line for the Momentum indicator.
A ten-day period is a fairly common calculation period. Nevertheless, for analysis, you can take any length of time. With a shorter period - say, up to five days - the sensitivity of the indicator curve increases, which leads to an increase in the frequency of its oscillations. Long periods, for example twenty-day ones, appear in the form of much smoother curves with a less pronounced oscillation frequency.
So, using a 10-day momentum, we compare today's closing price with the price of ten days ago. If today's closing price is higher, then the indicator will be positive. If today's closing price is lower than the price ten days ago, then the value is negative. When using momentum, it is assumed that the price difference (the difference between the current closing price and the price some time ago) should steadily increase as the trend develops. In other words, the rate of price change is increasing. If prices rise, and the indicator begins to level out, then the trend is slowing down. This may be an early sign of its end.
Momentum is the simplest trend indicator. Its formula is so simple and intuitive that it does not require a description. The excess of current closing prices over the past shows an uptrend, and if current prices are lower than past for the selected time interval, this means a downtrend.
Smooth momentum is sometimes used to reduce its volatility. For these purposes, moving averages are used.
Classically, the value of the Momentum indicator is calculated as the difference between the closing levels of the last and first bars in a single interval. The size of the interval depends on the indicator coefficient and, in most cases, is assumed to be 14. The formula is as follows:
M (j) = CLOSE (j) - CLOSE (j - n),
where M (j) is the value of Momentum;
CLOSE (j) - closing price of the current bar;
and CLOSE (j - n) is the closing price of the bar that appeared on the chart of quotes n timeframes back.
It can be seen from the formula that the value of the indicator can be both positive and negative. And the more Momentum departs from zero, the more clearly expressed on the market are oversold or overbought conditions. Moreover, for different intervals and different currency pairs, the amplitude of Momentum fluctuations will be very different.
The above formula is taken from John J. Murphy's book “Technical Analysis of the Futures Markets” and is considered a classic formula for calculating the indicator.
However, there is another variation of the calculation of the Momentum indicator according to the book by Stephen Akelis “Technical analysis from A to Z”, in which Momentum coincides with the Rate of Change and is defined as the ratio of the current price to the price that took place n periods ago:M (j) = CLOSE (j) * 100 / CLOSE (j - n)
In the MT4 trading terminal, Momentum is calculated using the second formula, so it does not fluctuate around zero, but around level 100.
It was this formula that at one time migrated to many technical analysis programs, but it is not correct enough.
There is also a separate formula called Chande Momentum Oscillator (CMO). It is calculated as follows:
MomentumSimple = C - C-n,
where C is the closing price of the current period, and C-n is the closing price of n candles back.
If MomentumSimple> 0, then M1 = MomentumSimple, and M2 = 0;
If MomentumSimple <0, then M2 = -MomentumSimple, and M1 = 0.
Use as an oscillator
No matter how convenient it is to use this indicator, the following question arises. Oscillator analysis is most convenient in case of extreme price positions. But how can we determine how strong or weak the market moment is at the moment, if we have not set any criteria other than the zero line? This problem can be solved in two ways: either visually assess the magnitude of the Momentum in comparison with its previous ups and downs, or turn to other oscillators.
This is not to say that the first solution to the problem is completely unacceptable. Just define the historical higher and lower levels of Momentum and each time we will compare them with the current value. A sell signal appears when Momentum or its moving average rises by a significant amount, reverses and begins to fall.
A buy signal appears when Momentum or its moving average falls by a significant amount, turns around and begins to rise up. This “significant amount” will vary on each currency pair on Forex and needs to be tested separately. Moreover, this value will be different over different time periods.
At the same time, it is more convenient to normalize the Moment graph, de la values to the largest amplitude reached. As a result, it will vary from - 1 to + 1. Reaching the danger zone, i.e. approaching in absolute value to unity, the value of the Moment signals a weakening or strengthening of the price trend. For example, the achieved value of 0.95 indicates that the price is rising too fast and the next stage will be consolidation or even decline.
The idea of normalizing the Moment was implemented as a Commodity Channel Index. Donald Lambert, the author of this index, uses as an divider the average price for those few days for which the calculation is made, after which multiplying the resulting value by 1.5. The resulting curve is completely similar to the Moment, but its fluctuations are considered in relation to the levels of -100 and +100.
Use as a trend indicator
The Momentum indicator can be used on Forex as a trend indicator. In this case, the intersection of its zero line is used as a signal. When the line crosses from top to bottom, a sell signal is issued, and when from bottom to up, a buy signal is issued.
A deal is made at the opening of the next candle, if this opening (and closing of the previous candle) occurs in the direction of the breakdown of zone 100. Stop-loss is set for the last price extreme.
If prices make a new high on the chart, which is higher than the previous one, and Momentum at that time makes a new high on its chart, but lower than the previous one, this means that an upward downward movement may soon begin. And vice versa: if prices make a new low on the chart on the chart, which is lower than the previous one, and Momentum at that time makes a new low on its chart, but higher than the previous one, this means that a downtrend may start to turn upward soon.
Analysis of indicator extremes
It is necessary to carefully monitor the extremes achieved by the indicator. The fact is that extremely high or low values of the Momentum indicator suggest a continuation of the current trend. If the indicator reaches extremely high values and then turns down, further growth in prices should be expected.
As you can see in the figure above, visually highlighted very high and very low values of the indicator with subsequent rollback confirm the continuation of the trend. Thus, at the pullback, after a particularly high peak, you can look for the opportunity to enter the purchase.
A sharp jump in the momentum indicator, as a rule, is a signal that the market is approaching its peak. After a sharp rise or fall of the indicator, as a rule, there is a reversal or stop of the price movement. At such moments, it is best to close previously open positions or, at a minimum, close to press the stops.
Momentum and its moving average
The momentum indicator works very well together with the moving average, built according to the indications of this indicator. You can build a moving average as follows:
In the figure below, according to the readings of the Momentum indicator (48), EMA (8) is constructed according to the settings from the figure above:
Input signals are generated by analogy with an indicator such as Stochastic. When the indicator crosses its moving from top to bottom above level 100, it becomes possible to enter sales. For purchases the opposite. In this approach, it is the distance to level 100 that is quite important - the farther the intersection is from the level, the more reliable the signal.
Combination of methods
It is worth noting that the use of Momentum as an oscillator together with a trend indicator is more reliable. Moreover, this role can be played by Momentum itself with a large period. If the trending Momentum is above 100 (in the ideal case, with a consistent update of its own highs), then you should make purchases when the shorter Momentum drops to 100 and pushes up. At the opening of the next candle after such repulsion, you should make a purchase by placing a stop below the last extremum. The converse is true for a downtrend.
After the long Momentum on the chart above stopped updating the lows and broke the zero line up, sales were no longer made. Thus, Momentum with a larger period can be a trend indicator, and provide leading information about the development of the trend. The trader should look at the nature of the extremes on the trending Momentum to confirm the trend.
Moreover, the trend Momentum can form divergences with the price, stop updating extrema in the body of the trend by the indicator when the extremum is updated by the price. This signal is especially good when the trend Momentum breaks its trend line and the shorter Momentum gives a buy signal by touching and pushing from line 100 towards divergence.
Momentum is a simple and at the same time effective indicator that can be both an oscillator and serve as a trend indicator. Also, this indicator shows that the methods for calculating indicators over time are also capable of changing.
Remember, there are no indicators on Forex that are not mistaken. The Momentum indicator, like any others, requires confirmation of its signals. When building your own trading system, use several indicators.
Clearly follow your trading strategy, trading plan and money management. If according to your strategy you need to open a deal - open it, if you record the result - fix it, and it does not matter if you are in the black.