Momentum traders would open and close positions within a trend, rather than at the top and bottom.
Momentum indicator - Technical Analysis
As you can see from the above price chart, the signal line remained in the overbought territory for a sustained period of time. This makes it important to use the RSI alongside other indicators. Moving averages MAs are used by traders to spot emerging trends in markets. They use a formula that filters out random fluctuations to show a prevailing price trend. Although MAs are not a momentum-based indicator, they can help momentum traders see whether a market is rangebound or not.
For example, on the above chart there are three moving averages applied: a day, day and day. For the most part of the price action, the moving averages MAs are on top of each other, with the shortest-term MA on top and the longest one on the bottom. This tells us that the market is trending, and that the trend is accelerating. When using moving averages, it is important to be aware that they are a type of lagging indicator — this means that the signals happen after the price move. As you can see from the above chart, the MAs cross over — indicating a trend reversal — after the price has already declined slightly.
The stochastic oscillator compares the most recent closing price to the previous trading range, over a specified period of time.
Understanding and Trading with the Momentum Indicator
This indicator does not follow price or volume, but rather the speed and momentum of the underlying market. The stochastic is considered a leading indicator, so it can be used to predict price movements. It is formed of two lines on a price chart:. If the stochastic fails to fall back to the 20 mark during a pullback, then it can be taken as a sign that the trend will continue upward.
For example, looking at the price chart above, we can see that on the whole the two lines have remained above the oversold signal, and the trend has continued upward. This is an indicator that despite pullbacks, the overall momentum is up. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument.
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Inbox Community Academy Help. Log in Create live account. Charges and margins Volume based rebates CFD account details Swap-free trading account What is swap free trading and how does it work? Related search: Market Data. Market Data Type of market. Learn to trade Strategy and planning. Momentum trading strategies: a beginner's guide. Becca Cattlin Financial writer , London. What is momentum trading?
Momentum in finance is based on the following key factors: Volume Volatility Time frame. Volume Volume is the amount of a particular asset that is traded within a given time frame.
Time frame Momentum trading strategies are usually focused on short-term market movements, but the duration of a trade can depend on how long the trend maintains its strength. Momentum indicator The momentum indicator is, as you might expect, the most popular momentum indicator. Moving averages Moving averages MAs are used by traders to spot emerging trends in markets.
Stochastic oscillator The stochastic oscillator compares the most recent closing price to the previous trading range, over a specified period of time. It is formed of two lines on a price chart: The indicator line: this is a rangebound line that oscillates between zero and — if there is a reading of over 80 the market is considered overbought, and if there is a reading below 20 it is considered oversold The signal line: this is drawn onto the same price chart. If the signal line and indicator line cross, it shows that a change in direction is likely to happen.
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But first we need to establish what these rules are. We can keep this six-point spread symmetrical based on trend. For an exit signal on long trades, we can take a touch of the period simple moving average SMA or a move below on the momentum indicator. For an exit signal on short trades, we can take a touch of the period SMA or a move above 94 on the momentum indicator.
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On the very left side of the chart, there was an upward breach of on the momentum indicator but no concomitant upward touch of the Keltner Channel. But we finally see both occur later on, marked by the first vertical white line that extends across both charts. The horizontal lines show the price levels of the trade and show a decent profit for the short trade taken as part of the rules associated with this system.
We need a break of momentum above or below 94 , a touch of the top band of the Keltner Channel or touch of the bottom band , and either a drop of momentum back into the range or touch of the period SMA. Again, the horizontal line on the momentum indicator bottom chart represents the level. The first vertical line on both charts represents the instance where our criteria was satisfied resulting in a short trade. The second vertical line denotes trade exit due to a touch of the period SMA. The horizontal line on the top chart show the entry and exit prices.
This trade made a slight profit. For a breakout strategy, we trade in the direction of high momentum levels, rather than taking a stretched momentum indicator reading as a price reversal signal. For this we need to set up a new set of indicators. To keep things simple, we can use moving averages. For them to have value they need to be shorter in length. Trading with momentum is inherently a strategy that uses a short-term timeframe. We can set up a system involving both 5-period and period simple moving averages.
The periods, as they relate to the daily chart, would encapsulate data from the past one week and one month, respectively. And thus our system for long trades will be based around the idea that the momentum indicator must be breached above a certain predetermined level with the fast SMA above the slow SMA. The reverse would be true for short trades, where momentum must get below a certain level with the fast SMA below the slow SMA.
This illustrates how different traders may view markets differently which is of course good as differing opinions and approaches are what make a market in the first place. Our trade criteria are met on the long side as momentum moves above the level and the 5-period SMA moves above the period SMA. This captured a large part of the up move as this particular market went exponential. Momentum fell below and the SMA crossed right around the same time, giving us indication to exit the trade.
The horizontal white line on the bottom chart show the momentum level. The vertical lines show the time interval for which the trade was open. The horizontal white lines on the top chart show the price levels of the entry and exit. In this case, we have two trades. We see a rise in the momentum indicator above Once again, the horizontal line on the bottom chart denotes the momentum level. The vertical lines on both charts show trade entry and exit. The horizontal lines on the price chart show the price level of the entry green arrow and price level of the exit white arrow.
This allows for a long trade green arrow.