Indicators

Best Momentum Indicators

Written by Forex Trading Bot

Momentum indicators are those tools that traders and investors use to analyze the speed at which the prices of securities change in the trading market. Momentum indicators are also called oscillators, and their depiction is via either line graphs or histograms. The oscillation of these trading indicators gives insight into the behaviour of market prices and the prevailing trend. Momentum indicators are best used with other forex indicators as they don’t identify the direction of movement, only the timeframe in which the price change is occurring.

A typical momentum indicator compares the most recent closing bar against its previous counterparts to determine the prevailing market trend.

Why use Momentum Indicators?

Momentum indicators show the price movement over a specified time period; how strong those movements are or will be, regardless of the direction the price moves, either upwards or downwards.

Momentum indicators are primarily useful as they help traders and market analysts spot significant price points with the potential for market reversal. Identification of these price points is through divergence between market price movement and momentum indicator movement in use.

Momentum Indicator Signals

Momentum trading indicators show the relative strength of price movements without showing the trend direction.

Therefore, they are not solely utilizable as individual trading indicators. It is always prudent to combine them with other technical trading indicators.

Divergence

Divergence in forex trading occurs when the market’s direction is in the opposite direction to the trading indicator’s movement. This phenomenon is referred to as indicator divergence and shows that the market’s momentum is in decline and a trend reversal is around the corner.

Divergence primarily indicates that the current market trend is no longer sustainable due to waning market momentum.

When price movement and market momentum diverge in an upward fashion, it is a bullish divergence. Suppose price movement and the momentum indicator were continually moving upward and the momentum indicator suddenly turned to the downside, it would be a bearish divergence.

You can likewise search at a pullback during a moving economic situation where cost activity is separated from the Momentum marker. A difference exchange arrangement lined up with the general pattern will probably give a higher achievement rate than evading a definite pattern and attempting to pick a top or base. While endeavouring a counter pattern exchange with energy difference, it is significant that you have extra proof that a pattern inversion is likely. Regardless of how far a market has expanded or how great a counter pattern uniqueness signal looks, it could be a bogus sign, and the market could keep on moving.

Crossover

To buy or sell on based on a crossover, a moving average that acts as the signal line has to be incorporated. The moving average period is based on the average closing price over specified number of days.

Buy when the momentum indicator crosses above the moving average from below, and sell when the momentum indicator crosses below the moving average.

100 Line Cross

One type of signal provided by the Momentum Indicator is the 100 Line Cross. When price moves from below the 100 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 100 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.

For example, you may want to wait for prices to pull back to or below the 100 line from above and enter after price crosses back above the 100 line in an uptrend. You could filter that condition with something such as a 3 bar breakout for entry.

The Best Momentum Indicators

Rate of Change Indicator

Rate of change indicator is regarded as a pure momentum indicator and compares the historical prices of trading instruments with the prevailing market price. It is plotted as an oscillator that fluctuates below and above the 0 level: upward rate of change movement shows a sharp price surge and the downward leap signifies a sudden price fall.

The following formula is used to calculate the rate of change:

  • ROC = {(Current day’s Closing Price – Closing Price ‘n’ periods ago) / Closing Price ‘n’ periods ago} x 100

The Average Directional Index Indicator

This indicator typically assists the trader or investor in measuring the strength of a trend. This indicator estimates the price strength of securities in both directions positive and negative. When the Average Directional Index appears to exceed 25, it suggests a strong trend, whereas if it appears to be less than 20, it means that no market movement exists. To calculate the Average Directional Index, you have to obtain the average mean of indices’ value over a specific period.

The Moving Average Convergence Divergence

This indicator is perceived as the best momentum indicator as it is primarily useful in trading trends. Despite not being an oscillator, the MACD indicator helps identify overbought and oversold conditions. On the trading indicator chart, the moving average convergence divergence, MACD, the indicator is plotted as two graphical lines.

If the MACD indicator climbs above the 0 level, the market is deemed to be bullish, whereas the market is considered bearish if the indicator dives below the 0 level.

The algorithm for calculating the MACD indicator is as follows:

  • MACD = 26 period exponential moving average – 12 period exponential moving average.

The above is coupled with a signal line of the preferred period, standard one uses a period of 9.

The Relative Strength Index

The relative strength indicator is a type of momentum indicator which measures the change and speed of price fluctuations. This indicator oscillates from 0 to 100. RSI is usually considered as overbought upon breaching 70, and it is deemed oversold upon falling below 30.

This indicator generates signals by observing both divergences and incompetent swings. The RSI indicator also helps identify general trends. If the indicator shows overbuying, it is deemed as an excellent time to sell your securities and make profits. Similarly, if it indicates overselling, you should buy securities.

The following formula sums up the Relative strength index algorithm:

  • RSI = 100 – [100 / (1 + (Average of Upward Price Movement/ Average of Downward Price Movement))]

Instead of using a simple relative strength index indicator, traders can use a modified RSI known as the Laguerre RSI indicator. Laguerre RSI overcomes the simple bane of choppiness and false positives by employing a gamma coefficient to a weighted moving average.

A bullish price rally with momentum is validated by the RSI being above either the 50 level, using 0-100 scale, or by the RSI being positive if oscillating around the 0 level.

Besides, if the relative strength index indicator movement is contrarian to the prevailing market trend, moves in the opposite direction, it shows reduced market momentum and potential for a trend reversal.

Stochastic Oscillator Indicator

The stochastic oscillator is a popular momentum filter indicator. There are a plethora of trading strategies based on the stochastic oscillator indicator. This momentum indicator oscillates between 0 and 100, showing the market price’s relative position in a given timeframe.

The %K period settings indicate the market price position: A smoothed indicator uses a higher period than the active trading timeframe effectively reducing false positives. On the other hand, the %D is a plotted moving average of the %K settings. Its settings are dependent on the desired level of trading activity, a higher period for more trading activity, and vice versa. The moving average to use is dependent on the desired level of lag to the prevailing prices.

Whenever the market prices hit the 20 and 80 level, they indicate market overbought and oversold regions, respectively.

Conclusion

The momentum trading indicators discusse herein are vital tools for both market analysts and traders. However, they ashould never be used as sole indicators for a trading system. It is advisable to utilise them in conjuction with other technical indicators that reveal the directions of trends.

Once a direction’s been determined,

momentum indicators are valuable because they indicate the strength of price movement trends and when they are coming to an end. As discussed, three primary trading signals can be generated with the Momentum Indicator.

These signals include the 100 Line Cross, the Momentum Crossover, and the Divergence signal.

If you adhere to these rules,  you are less prone to experience market whipsaws that stop out tour positions. you also get to avoid false positives exponentially increasing your winning rate

Through this guide, you should now be more proficient about the general utilization of Momentum Indicators: there application and execution should be a thing of the past.

Remember that momentum indicators require validation due to false positives. As such, always couple momentum indicators with other trading indicators that confirm the market direction and the existing market momentum.

Final word, back-test all of these momentum indicators to familiarize with the perfect trade setups that lead to profitability.

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Forex Trading Bot