Most technical indicators are based on the fundamental belief that volume precedes
price. Momentum is a key concept that traders must master if they want to effectively
understand most technical indicators. Momentum is defined as the rate of the rise
or fall in price. Momentum simply measures the speed or velocity of price changes.
An easy way to understand this is to visualise that momentum compares the magnitude
of recent gains to recent losses in an attempt to determine overbought and oversold
conditions. Most important thing to understand is that momentum is a leading indicator
of a change in direction of price i.e. changes in momentum will precede changes
M = V – Vx
Where V is the latest price, Vx is the closing price n days ago.
Traders can track the direction of the trend by monitoring a momentum indicator.
In an uptrend the indicator is positive and negative while in a downtrend. The strength
of a trend is identified by how high or how low the indicator is. The momentum calculates
data in absolute changes, and measures the strength of the current trend is measured
by how high or low indicator reaches from different bases.
When momentum is positive prices are rising and momentum is negative when prices
are falling. This translates into a positive momentum indicator that will increase
long as prices keep rising and a negative momentum indicator that continues to decrease
as long as prices keep falling. There is no upward boundary on the Momentum indicator.
The Momentum indicator is most commonly used to identify overbought/oversold extremes,
indicator trend line breaks, and Centre-line crosses.
By watching for extreme price levels traders can avoid buying at tops and selling
at bottoms. The best way to use the momentum indicator is too for opportunities
to trade in the direction of a prevailing trend by initiating a position on a pullback
This trading method is quite simple. Long trades are entered when Momentum line
crosses its centre-line from below. Short trades are entered when Momentum crosses
its centre-line from above. This is a trend-following approach to using this indicator
as the direction of the trend is signalled as momentum is positive or negative.
Another way of trading this indicator is the Trend-Line break on indicator line.
In this method, the traders can utilize trendlines in the Momentum indicator and
enter trades on a break of the trend line. This is a contra-trend strategy as the
trend on the price chart would still be intact. By trading break of a trend line
on the Momentum indicator, traders can spot weakening trends that may not show up
on the price chart at all.
RSI and the momentum indicator are versatile momentum indicators that can be used
by traders in a number of ways. In simplest use, indicators can stop traders from
buying at tops and selling at lows. Momentum indicators can help traders’
time entries to trade in the direction of the trend on pullback opportunities. Positive
and negative divergence can help traders see weakening trends that may not appear
in price charts. The momentum and RSI index can help novice traders take some of
the mystery out of why some trends begin or end.