Momentum Indicator : Know how to use it

A momentum indicator (oscillator) is a technical indicator which shows the trend direction and measures the pace of the price fluctuation by comparing current and past values. It is one of the leading indicators that measure the rate of change of securities. A momentum indicator is generally used in unison with other indicators.

How to Use Momentum Indicator?

A momentum indicator is depicted by a line that oscillates around 100. Since a momentum indicator is an oscillator, it must be used inside the price-trend analysis. There are many momentum indicators, and the following are the widely used ones:

Relative Strength Index

The RSI indicator measures the speed and change of price fluctuations. It oscillates between zero and 100. Generally, the RSI is considered overbought when it breaches 70 and oversold when it falls below 30. Signals are generated by observing divergences and incompetent swings. RSI is also used in identifying the general trend. When the RSI indicates overbuying, then it’s considered a good time to make profits by selling. Similarly, when the RSI indicates overselling, it is considered the best time to buy. Formula to calculate RSI; RSI = 100 – [100 / (1 + (Average of Upward Price Movement/ Average of Downward Price Movement))]

Moving Average Convergence/Divergence

The MACD is majorly used in trading trends. MACD is not really an oscillator. It is still used in identifying oversold and overbought conditions. MACD is seen on the chart as two lines with no boundaries. The market is considered bullish if the MACD is above zero, else bearish. Formula to calculate MACD; MACD = 12 period EMA – 26 period EMA; where EMA is the exponential moving average.

Average Directional Index

The ADX is used to measure a trend’s strength. It is an average of expanding values of price ranges. ADX tries to estimate the price strength in both positive and negative directions. If the ADX is more than 25, then it suggests a strong trend. If the ADX is less than 20, then it suggests there is no trend. Formula to calculate ADX; ADX is calculated by obtaining the mean or average of the values of indices over a specified period.

Rate of Change

The ROC is a pure momentum oscillator. It compares the price ‘n’ periods ago with the current price. The ROC plot develops into an oscillator, which fluctuates below and above zero. The upward movement of ROC depicts a sharp price surge, while a downward leap represents an abrupt price slump. Formula to calculate ROC; ROC = {(Today’s Closing Price – Closing Price ‘n’ periods ago) / Closing Price ‘n’ periods ago} x 100

How to use Momentum Indicator for Intra-day Trading?

Choose one or two indicators to keep a track of entries and exits. RSI can be used in quarantining the trend and entry points. For instance, the RSI can be used to separate entry points and trend. During uptrends, the RSI must be exceeding 70 on rallies and sojourning above 30 on bearish trends. MACD can be used in deciding when to exit. For instance, MACD can be used in tracking stock loss in trading trends. If the trend seems to be upwards, then you can consider exiting when the price falls beneath the line. You can follow other indicators and combine them in the manner explained above for intra-day trading using momentum indicators.