The momentum indicator has a function as a trend following indicator, trend reversal and as a leading indicator with divergent signals that occur.
In technical analysis, indicators have an important role to sharpen a trader’s analysis.
Technical indicators collect historical data on price movements and present it in the form of lines or dots.
In contrast to fundamental analysis, which utilizes economic data and state conditions.
There are two types of indicators according to the application on the graph.
Namely Oscillator (under the chart) and Overlay (stacking on the chart).
One of the oldest indicators of Oscillator that has been created is Momentum. indicator.
Although this indicator has been found for a long time, there are still many traders who use it in their trading activities.
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Momentum indicator explained
Momentum indicator to measure the speed and magnitude of price changes within a certain time period.
Generally, the momentum indicator will be moving up when the trend is strong, and vice versa will moving down when the trend is weakening.
In the application of trading, some use derivative momentum indicators such as using MACD with moving averages to determine trends.
But there are also original momentum indicators that are built into the MetaTrader platform, to display momentum indicators, simple click insert -> indicator – >> oscillator – >> momentum.
Let us discuss both of them, how to use the original momentum indicator and use the derived momentum indicator.
How to use the original momentum indicator?
Momentum Indicator is a technical indicator made from simple calculations by measuring the difference in the price of today’s Close compared to the price of a Close a few days before.
This is one of the oldest oscillators ever found, sometimes also called the Rate of Change (ROC).
Momentum indicator can be calculated with two formulas:
Momentum = Price Close Today - Price Close N Past Days Momentum = (Today's Close Price / Price Close N Past Days) * 100
N here can mean whatever period you specify.
So that means if you write down 14-day momentum for the price of X
Then the way to calculate it is to subtract the price today with the price 14 days ago.
Currently, the application is even easier because of the trading platform Metatrader4.
The Momentum indicator is available in the Oscillator indicator list so that traders do not need to calculate themselves manually.
There are generally three ways to use the Momentum indicator.
- As a confirm the trend.
- Trend reversal indicator
- As a leading indicator with the analysis of the divergences occurs.
Momentum indicator as confirming the trend
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To confirm a trend, using the momentum indicator is to add level 100 to the indicator.
The trick is simple, click the properties indicator – >> level – add, write the number 100 then press ok
How to use the momentum indicator is very simple.
- If the price crosses the level 100 from bottom to up, this is a bullish signal
- Conversely, if the price crosses level 100 from top to bottom, this is a bearish signal.
But because this indicator gives a lot of false signals appearing, then you need to use other indicators, for example with the simple moving average for the period of 20, and you can use another indicator to combine with a momentum indicator.
Thus will be a signal filter, to get the best entry.
You can see in the picture above, if without using the SMA indicator filter, false signals will often appear, and if you follow all the signals, the loss will likely come several times.
However, by adding a filter for the SMA indicator, the signals that come will be more minimal, and this also prevents over-trading.
Momentum indicator to confirm trend reversal or continuation
Momentum indicators are also used to identify reversal or continuation trends.
By looking at the value of the indicator at the top and bottom, this can be used as a way to determine overbought and oversold.
So by paying attention to the shape of the candle and the indicator SMA 20, this can be used as a trigger whether there is a trend reversal or continuation.
However, to detect this reversal trend requires an in-depth analysis, if you look at the indicators above.
That the extreme value is at a number above 101.
But in fact, it still swings twice, so that a late exit point might cause a loss.
Thus the understanding of the current trend is what determines the success or failure exit points.
The late-to exit might the price can rise again.
Momentum indicator for divergence
Like other oscillator indicators, it turns out that momentum indicators are also used for divergence analysis.
How to read the divergence on the momentum indicator is also the same as using other indicators, such as MACD, by looking at the slope of the peaks and valleys of the indicator against the price.
How to use Momentum for other indicators
Next, we will learn about using another momentum indicator, MACD combined with the moving average indicator, here we use EMA.
Using this indicator may get a delay in determining the entry, but gives a smaller chance of mistake.
The picture above is a GBPUSD pair by plotting the EMA 10 and EMA 20 and MACD indicators.
We already know the basics of trading with fast EMA crosses with slow EMA and MACD.
From the example above we get one buy signal, and two sell signals confirmed by MACD and EMA cross.]
From the signals that appear can provide easy profits because after the Buy, a signal appears you see the price and then rise sharply.
Likewise, the Sell signal gives a good profit because this is not a fake signal.
But you also have to be careful, because the crossing of the EMA is not certain to be correct, sometimes it also gives a confusing signal.
Now we take the following example.
In the chart above you can clearly see that MACD has given a Buy signal, while the EMA cross has not been confirmed and there is no signal.
If you open buy then the possibility of loss due to rising prices continue the trend.
The second MACD signal first gives a buy signal, and EMA is still no signal, this condition is indeed confusing if you open buy then a loss might occur.
It is better to enter both indicators giving the same signal as in the first example.
The original momentum indicator is available on the MetaTrader 4 trading platform, but many traders prefer to use the momentum indicator such as MACD, Stochastic, RSI and so on.
Using a combination of several indicators is not a guarantee that it will give a valid and profitable signal.
But at least it will reduce the way you trade blindly.
Using momentum indicators is only a tool, in practice you need a low-risk trading plan, using secure lots and measured risk management.