- Momentum Defined
- Momentum Divergences
The Momentum indicator compares where the current price is in relation to where the price was in the past. How far in the past the comparison is made is up to the technical analysis trader. The calculation of Momentum is quite simple (n is the number of periods the technical trader selects):
- The current price minus the price n-periods ago
Hence, if the current price is higher than the price in the past, then the Momentum indicator is positive. In contrast, when the current price is lower than the price in the past, then the Momentum indicator is negative.
An example of the Momentum indicator is shown below in the chart of the E-mini Nasdaq 100 Future:
Potential buy or shortsell entries are shown above in the chart.
Momentum Potential Buy Signal
When the Momentum indicator crosses above the zero line. The crossing of the zero line implies that the price of the stock, future, or currency pair is reversing course, either by having bottomed out or by breaking out above recent highs; this is typically viewed as a bullish signal.
Momentum Potential Sell Signal
Momentum indicator crosses below the zero line. A cross of the zero line can generally mean two things: the future, currency pair, or stock's price has topped out and is reversing or that the price has broken below recent lows, either way, these events are often interpreted by traders as bearish signals.
Momentum Potential Exit Signals
Generally speaking the potential buy and sell signals discussed above are poor exits, either selling out of a long position or buying to cover a short position. By the time the Momentum indicator returns back to the zero line, most or all of the profits have probably eroded, or even worse the trader has let a winning position turn into a losing position.
When the Momentum is reversing course and is heading back towards the zero line, that means profits have been eroded. How much of a retracement back towards the zero line before an exit is triggered is up to the trader. Another possible alternative is to draw a trendline; when the trendline is broken, that might act as the exit signal. Like most technical analysis indicators, interpreting them is part science, part art form.
Potential buy and sell signals are not the only use of the Momentum indicator. The next page discusses using Momentum to detect divergences, an important trading concept.
Next Page - Momentum Divergences
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