Momentum indicator – Trading Tutorial & explanation

First hour indicator

Looking at the charts, it becomes clear that prices always move in certain waves and trends. The momentum indicator (often referred to as “the momentum”) as one of the first generation indicators tries to show the relative change in prices over a set period of time, whereby the indicator oscillates around a 100% mark. In the following, the strengths and weaknesses of the Momentum Indicator will be described in detail.

The calculation of the indicator

Momentum = Close(today) / Close(n days ago) * 100

Features of the Momentum Indicator

In contrast to a real oscillator in the sense of technical analysis, there is (theoretically) no fixed value range in momentum.
If the momentum indicator moves above the 100% line, there was a price increase in the set period of time, and price losses in the area below the 100% line. The further the price moves away from the 100% line, the stronger the price gain/loss and thus generally also the trend strength, according to theory.
The momentum indicator is interesting above all because it manages to see a little into the future and thus trend reversals in the indicator are often formed before the trend reversal in the prices. The “momentum” is comparable to the speed of a cannonball that shoots vertically upwards, which flies quite fast at first, then “looking ahead” slows down and slows down until the high point is reached and the cannonball falls back to earth accelerating. Similarly, prices and momentum before the trend reversal behave in a similar way.

The signals of the momentum indicator

For the Momentum Indicator (hereafter referred to as “the Momentum”), a setting of 12 – 20 days is generally proposed for short-term developments. The momentum with a 14-day period is probably the most common.

  • The literature speaks of an intact Upward movement, when the momentum moves steadily above the 100% line
  • Below the 100% line, the downward movement is considered confirmed
  • In both cases mentioned, reaching an extreme position is a warning signal! Unfortunately, it is left to the analyst to define this extreme position, since there is no fixed value range
  • Very good indications are provided by divergences between the indicator line and price movement. Here the indicator is running ahead of the prices
  • In the USA, the breaching of the 100% line is used as a buy/sell signal. I find this signaling very questionable

The breakthrough through the 100% line

The diagram above shows that the momentum can sometimes provide good signals. Unfortunately, there are of course also false signals in the momentum. For example, the buy-signal around 11th April was very unlucky, as well as the sell-signal in mid-May.

Convergences/ Divergences

Constellations in which the price and the indicator move in opposite directions are an important warning signal. At the top of the chart, you can first see how a divergence builds up. The Dow Jones forms new highs in points (1) and (2). These are accompanied by falling levels in the indicator. This bearish divergence is a clear warning signal. The collapse occurs immediately and a bearish convergence forms in points (2) and (3).

Points (4) to (6) now form a bottom with rising lows in the DOW and the convergent momentum, the trend is turning.
One should definitely adjust the length of the period of the Momentum indicator to one’s own trading habits. Relatively long settings smooth the Momentum indicator and then form clean divergences. Another possibility is to superimpose several variants of different period lengths and thereby generate filters.

Weaknesses of the Momentum Indicator

The momentum indicator is very weak in times of sideways movements, where several false signals often follow in succession. In addition, very fast movements – for example a more extensive GAP – can strongly distort the indicator, this is due to its simple calculation. One should therefore under no circumstances try to build trading systems solely on the basis of the momentum indicator.

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