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 indicators and other signals. In 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.
How to Calculate the Momentum Indicator?
The Momentum Indicator or MI compares the current closing price to a particular closing price “n” periods in the past. The “n” period is an input value that is determined by the trader himself. Most of the charting software programs use momentum indicator settings of 10 or 14 for the input valuation. So after that, if you set “n” to 10, that would compare the current closing price to the closing price 10 periods ago. Here is the detail 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 kite.
Set up the MI on 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 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.
Set up the MI on Upstox Pro
In Upstox pro also, the setup process is almost the same as Kite. First, log in and set up the chart and then customize the indicator as per your requirement. Lastly, click on the apply option.
How to Use Momentum Indicator (In Brief)
The momentum indicator is represented by a line. The indicator oscillates around 100. Being an oscillator, momentum should be used within the price trend analysis.
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.
- Now, when the price hits a new high, but the indicator does not, that may mean that investor sentiment 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 in Detail
So, here is the detail of the buy-sell strategy of the indicator.
For Momentum Potential Buy Signal :
The bullish or bearish signals are derived by the crossing of the zero lines as in few other indicators like MACD or Moving Average Convergence Divergence indicator. When this Momentum indicator 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.
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.
For Momentum Potential 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 stock’s price has topped out, is reversing or that the price has broken below recent lows. In either way, these events are often interpreted by traders as bearish signals or sell signals.
Momentum Divergence Signals
Momentum Divergence is a very simple yet strong concept in the technical analysis. Bullish divergence happens when prices are making lower lows, but the Momentum indicator is making higher lows.
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.
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 pushed too far. And also, like a rubber band effect, it requires revert into a value area.
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 it within the context of your own trading plan.