Momentum is one of the indicators used regularly in technical analysis. This indicator measures the acceleration in prices by comparing the closing price of the last session with the closing price of past sessions. The fact that it allows to observe the speed of movement in prices – in its graphical representation this would be seen as a change in its curve – makes it a very useful tool because it allows the trader to anticipate changes in the trends.
This indicator is calculated using the following formula:
- M = C – Cn
- M (Momentum)
- C (the last quote)
- Cn (the quote from a previuos session).
The variable ‘n’ refers to the number of sessions and is a function of the asset. Usually it is around 5 and 10 sessions.
The correct choice of the Momentum period is critical to achieve optimal results. The commonly periods used are of 5 sessions or 10 sessions. In the case of the Momentum of 5 sessions, the best practice is to use it for analyzing instruments whose price fluctuates quite a lot, because we obtain a curve that closely approximates that of the price but having an advantage over it: the anticipation. For other instruments is more effective to use a Momentum of 10 sessions, since in this case we obtain a slower fluctuation of the chart which allows more reliable signals.
Graphical representation of Momentum
he graphical representation of this indicator is a curve that moves around a neutral line (or zero line). The interpretation of this tool tends to focus on the moments in which the zero line and the line of Momentum cross each other. So when the line indicator cross the zero line following an upward trajectory, it is a buy signal, while when the Momentum line cross the zero line in a downward trajectory, is a sell signal. However, if the Momentum line is around the zero line continuously and with very few oscillations for a period of time, the recommendation is to stay away from the market.
Momentum line also serves to anticipate changes in the market trends. Thus, if prices are rising and Momentum line also rises but at the same time tends to decline (ie, a situation of divergency between the current market trend and the Momentum line trend), it indicates a slowdown, and we can probably anticipate a turnaround in prices.
The Momentum indicator is used, like other indicators that we have discussed so far, in conjuntion with other analysis tools. This allows to verify the signals produced by the indicator in order to open more reliable positions.