One of the key concepts of technical analysis is the trend. Many strategies are based on determining where the market is moving and whether it is at the beginning or end of the process. Such information is extremely useful for the trader. The probability of the continuation of the trend can be predicted by evaluating the intensity of trade. The strength of the market is often called an impulse, and there are a number of indicators created to determine it.
Trend strength measurement
The most famous indicators of market dynamics are the convergence and divergence of the moving average MACD, the relative strength index RSI and the stochastic indicator. The last two are oscillators, that is, their values ​​fluctuate in a limited range of values ​​(often between 0 and 100).
This article discusses another pulsed oscillator, which, according to some, is as effective as its more well-known counterparts. This is the “Momentum” indicator, which is a curve that oscillates on both sides of the centerline located at 100. Like RSI and Stochastic, it helps to determine the moment when players bought or sold too much. That is, does the trend have enough momentum to keep the price moving. When a falling market is oversold, a rebound is likely. When a growing market is overbought, it may fall.
Calculation formula
“Momentum” is a standard indicator that is available in many trading systems by default.
Calculating it is quite simple: each price is compared with the price for a certain number of time periods before that. The first step is to choose the number of periods N that will be used in the calculation. For example, in the MT4 system, N = 14 by default, but you can set any other number that the trader considers necessary to use.
Thus, the current closing price and N periods ago are compared. The formula for the Momentum indicator is as follows: Momentum = (Price / Price N periods ago) x 100.
The good news is that all calculations are done automatically and are instantly displayed on an additional diagram below the main one.
Description
The “Momentum” indicator is displayed in the form of a graph, the peaks and troughs of which reflect key shifts in the course dynamics. In this case, the center line may not be displayed. The higher the chart rises above 100, the faster the price moves up. The lower it drops, the faster it falls.
The momentum indicator is one of several trend oscillators available to traders. In addition to the standard RSI and Stochastic, there are additional indicators (for example, the stochastic momentum index SMI), but they can be used in many systems only after a separate installation and configuration.
The Momentum indicator in a trading strategy
Traders can use the pulse oscillator directly or as a confirmation tool.
The simplest signal is the intersection of the center line. At the same time, you should buy when the value rises above 100 and sell when the indicator crosses the 100 mark from top to bottom. However, this is a primitive approach and should be used with great care. Such signals are often late and arrive when most of the rise or fall of the price has already been passed.
The performance of the indicator can be improved by superimposing it on a moving average.
How to add a moving average?
Some traders like to compare the momentum curve with a simple moving average SMA.
This can be done by clicking on the Moving Average in the selection of Trend indicators in the MT4 navigator and dragging it into the Momentum chart. A standard dialog box will appear. In the "Apply to" drop-down menu of the "Parameters" section, select the "First indicator data" item. The moving average period can be selected by any, but the usual values ​​are 10, 14 or 21. The setting of the “Momentum” indicator is completed. In this case, the moving average line should be superimposed on the pulse oscillator in order to be able to use the signal that occurs when they cross.
A trading strategy is to buy when the indicator line crosses the moving average from the bottom up, and to sell when the movement is reverse. This should slightly improve the signal arrival time, but at the same time, the trader receives a lot of false signals. To eliminate them, only transactions in the direction of market movement can be taken into account. You can also take signals into account only after reaching the conditions of re-purchase or resale of the RSI indicator.
Confirmation tool
"Momentum" begins to perform a really useful function when used as a means of confirming the signals of a separate primary indicator. One of the best methods is to find the discrepancy between price and momentum as a way to measure trend strength. Impulse divergence is a simple but powerful concept for technical analysis.
Thus, a buy or sell signal will come from a pre-selected main indicator. Then it should be checked to see if the discrepancy between price and momentum is consistent with bullish or bearish trends.
Trend definition
Bullish divergence suggests that the market is oversold. The price drops to new lows, but the Momentum indicator (or another oscillator) does not create new lows.
A bearish divergence suggests that the market is overbought. The price rises to new highs, but momentum cannot reach a new level.
Such a dichotomy gives the trader only early hints of a weakening impulse, which can lead to a correction or a complete reversal of the trend. Divergences occur at the peaks of the market when prices change too much and, like a spring, should return to the real level.
Thus, it is enough to follow the signal to buy the main indicator, if it is confirmed by bullish divergence from the impulse. Likewise, it is necessary to track signals for sale, if they are confirmed by a bearish divergence.
The divergence works in different situations, but during strong trends it can give a lot of false signals. Also, do not use only this tool. Understanding what happens over a long period of time often helps filter out unlikely forecasts. Finding support and resistance levels and using them as a background can increase the chances of profitable trading.
Impulse of discrepancy in the Zigzag model
How to use the “Momentum” indicator in this case? The model is based on the Elliott Wave Theory. It consists of three waves: initial A, rollback B, which restores the price to less than 100% of the previous one, and continuation C, which moves in the initial direction and goes beyond it.
To create a trading strategy, it is necessary to determine the general trend of the market, find a zigzag correction and make sure the divergence of the model. If the divergence between the Momentum indicator and the price is confirmed, then the actual input signal will occur when the trend line breaks, which extends from the beginning of wave A to the beginning of wave C. In this case, the stop order must be placed outside the last swing created before the break of the AC line . The position closure point is the area at the beginning of wave A.
Pulse Compression Indicator
It is often useful to combine different indicators so that their various aspects complement each other. An example of this is the combination of the Momentum indicator and volatility measurements with the formation of a pulse compression indicator.
The Bollinger band forms a corridor, expanding during times of high volatility and tapering at low. Band contraction occurs when volatility is reduced to a historically low level. According to theory, something significant will follow such periods.
However, the Bollinger band indicator does not indicate the direction of the breakout. In a pulse compression strategy, the latter is used as a means of measuring where the market is moving.
Finally
In general, the momentum indicator is a tool that will be useful for a wide range of applications. It can be used both for stock market analysis, and as an indicator of “Momentum” on the “Forex”. It allows you to get three trading signals: the intersection of the value of 100, the intersection of the moving average and the discrepancy.
The versatility of the oscillator also means that you can easily create trading systems that work both in the short and long term. As a rule, for an impulse indicator, the shorter the time period used, the more sensitive it is. However, more false signals are generated.
Of course, this indicator is not the only way to measure trend strength. There are many other indicators of movement.