Momentum Indicator: Formula & Trading Strategy

Momentum Indicator

The Momentum Indicator is a leading indicator which is measuring a security’s rate of change. This is comparing the current price with the previous price from a number of periods ago. The ongoing plot forms an oscillator that moves above and below 0. It is a fully unbounded oscillator and it has no lower or upper limit.

What is Momentum Indicator?

This indicator is often used in combination with other technical pointers and other signals. This Momentum indicator is a speed-of-movement indicator designed to identify the speed or strength of price movement.

The particular indicator compares where the current price is in relation to where the price was in the past. And, how far in the past the comparison is made is up to the technical analysis trader.

Calculation and Formula of the Momentum Indicator

The Momentum Indicator or MI compares the current closing price to a particular closing price ā€œnā€ periods in the past. The ā€œnā€ period is an input value that is determined by the trader himself. Most charting software programs use momentum indicator settings of 10 or 14 for the input valuation. So after that, if you set ā€œnā€ to 10, that would compare the current closing price to the closing price 10 periods ago.Ā Here is the detailed calculation for the Momentum Indicator:

M = (CP / CPn) * 100

Here, M = Momentum, CP = Closing Price, n = close price n bars ago.

How to Set up the Momentum Indicator Like a Pro?

Now, I will show you how you can place the Momentum indicator like a pro. To set up the indicator, I take two charting platforms, Zerodha Kite, and Upstox Pro. First, go through the Zerodha Kite.

On Zerodha Kite

The Momentum indicator is present in the STUDIES section in the Zerodha Kite terminal. You can attach the indicator to any daily or intraday charts. Check the image below to understand how we attached the indicator in the HDFC Bank share price chart and what are the default parameters. The default parameters are 14, however, you can change the PERIOD as per your convenience.

Momentum Indicator In Zerodha Kite

In the same way, you can attach the indicator on the Kite mobile app.

On Upstox Pro

In Upstox Pro also, the setup process is almost the same as in Kite. First, log in and set up the chart and then customize the indicator as per your requirement. Lastly, click on the apply option.

Upstox Momentum Indicator

How to Use the Momentum Indicator?

The momentum indicator is represented by a line. The indicator oscillates around 100. Being an oscillator, momentum should be used within the priceĀ trendĀ analysis.

The 3 Ways to Use the Momentum Indicator

Crossing Over the X-Axis:

  • It is believed that if the M indicator climbs above 100 during an uptrend, it is a bullish signal
  • Reversely, if the indicator falls below 100 during a downtrend, a bearish signal appears.

Falling Out of the Normal Range:

  • Here, the extreme points mean that the price has posted its strongest gain or loss for a particular number of moving periods, and, supporting trend strength
  • Besides the above, if the price movement was too rapid, they may indicate possible overbought and oversold areas.

Divergence Patterns:

  • Now, when the price hits a new high, but the indicator does not, this is a divergence. That may mean thatĀ investor sentimentĀ is actually lower.
  • And oppositely, when the price falls to a new low, but the indicator does not support the drop, it is a signal that the trend may end soon.

Buy-Sell Strategy of the Momentum Indicator

So, here is the detail of the buy-sell strategy of the indicator.

Momentum Buy Signal :

We get the bullish or bearish signals by the crossing of the zero lines as in a few other indicators like MACD or Moving Average Convergence Divergence indicator. When this Momentum indicatorĀ crosses above the zero lines from below. The crossing of the zero lines implies which is 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 or a buy signal.

Momentum Indicator In Zerodha Kite

For another example, look at the 2nd picture below. There the oscillator crosses the 0 level line from below and it is the best time for the buyers to take an entry. As you can see after that, the price is moving upwards.

Crossing 0 line

Momentum Sell Signal :

When the Momentum indicator crosses below the zero lines from above. In this a cross of the zero lines can generate two things which are the future, currency pair, or the stock’s price has topped out, is reversing, or that the price has broken below recent lows. Either way, these events are often interpreted by traders as bearish signals or sell signals.

Sell Signal

Momentum Divergence Signals

Momentum Divergence is a very simple yet strong concept inĀ technical analysis. Bullish divergence happens when prices are making lower lows, but the Momentum indicator is making higher lows.

Momentum Indicator Bullish

On the same line of thinking, oppositely, a bearish divergence happens when prices are making a higher high, but the Momentum indicator is making a lower high.

Bearish Divergence

This dichotomy or divergence gives early clues to the trader of weakening momentum. This could lead to a price retracement or a complete trend reversal. Momentum divergences tend to happen at market extremes where prices have moved too far. And also, like a rubber band effect, it requires reverting into a value area.

FAQ

What is the best momentum indicator?

The Relative Strength Index (RSI) is widely considered to be the best momentum indicator. It measures a security’s speed and changes in price movements by comparing recent gains and losses over a period of time.

What are the three momentum indicators?

The three most commonly used RSI-related moment indicators are the Stochastic Momentum Index (SMI), Moving Average Convergence Divergence (MACD), and Rate Of Change (ROC). Each provides slightly different insights into market trends that can be used for trend identification, entry signals, stop loss placement, estimation of profit potential, etc.

What is the momentum indicator?

A momentum indicator tracks the rate at which prices have been changing over a given period of time and assesses whether a security or index is gaining or losing strength as indicated by divergences between current closing values and historical performance records. This information can show investors whether an asset has continued with its previous directional movement or if itā€™s slowing down just before potentially hitting either resistance or support levels.

How do you use momentum as an indicator?

To use momentum indicators effectively one should look for signs such as crossovers above/below moving averages crossover their midline along with confirmations from additional oscillator(s). Moreover using divergence analysis on prices Vs any leading/lagging indication might also prove beneficial depending upon the type of trading chosen i.e. intraday, swing trades, etc.

Conclusion

However, you must be more knowledgeable about the Momentum Indicator and also more comfortable with applying it in the market. So, we have already discussed some strategies which can be incorporated using the Momentum Oscillator. At the same time, that should only serve as a basic building block from which you can test different ideas or find valuable ways to incorporate them within the context of your own trading plan.


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