Forex Trading Strategies With Momentum Indicator
It still remains unknown who’s behind the “Momentum” indicator, but as a member of the “Oscillator” family of technical indicators, it’s a leading indicator that gauges the rate-of-change for a currency pair.
The momentum indicator tries to gauge the momentum that drives price movements for the currency pair in question over a specified period of time.
Traders deploy the indicator in spotting overbought and oversold conditions, as well as the strength of dominant trends.
Momentum is a term gotten off Newton’s first law of motion where an object in motion has a tendency to remain in motion until an outside force is applied to it.
Just like the law in Physics, a market in motion have a tendency to stay in motion than reverse which is why a strategy that involves momentum indicator is very important.
As shown in Fig. 1.0, the resulting curve fluctuates values around a “100” centerline, which does not necessarily gets shown on the indicator window, hence it is tagged as an oscillator.
When the curve touches maximum or minimum values, the price is said to be overbought or oversold respectively.
If the smoothed moving average is combined with the indicator, it enhances the reading of imminent changes in trend.
Software programs such as Metatrader 4 are available to do the necessary computational work.
All you need do is just add the indicator onto your trading chart and possibly modify its period away from the default value of 14 to suit your preference.
In most charting platforms, the momentum indicator is generated in respect to its price, although, some developers will have it pegged to volume.
Momentum = SMA(current) – SMA(N-periods ago)
The momentum is the change in N-period simple moving average (SMA) over a defined period of time.
The longer the period, the smoother the indicator will become.
The shorter the period, the more sensitive the indicator will become, thereby increasing its likelihood of choppiness and fake alerts.
Understanding Basic Momentum Indicator Signals
The momentum indicator is able to gauge when the price is surging upwards or when it’s dipping downwards, as well as by how much.
If the momentum indicator is seen to go above the 100, the price is said to be above the price “n” periods ago, and if the momentum indicator is below the 100, the price is said to be below the price “n” periods ago.
To ascertain how fast price is moving, you’ll need to look at how far above or below 100 the momentum indicator is signaling.
A reading of 105 reveals that price is heading faster to the upside than a reading of 102.
If the value of the momentum indicator is at 95, the price is heading downward with more force to the downside than a value of 97.
Although traders can also deploy the momentum indicator to provide trade alerts, it is usually better to use them in confirming trades based on pullbacks or breakouts in a trend.
1. The 100 Line Intersect
If price breaks above or below the 100 line, a buy or sell alert can be generated respectively.
If price moves above the 100 line, it depicts price moving higher since the price has moved above the price “n” periods ago.
If price dips below the 100 line, it reveals price is dropping and has gone below the price “n” periods ago.
The 100 or zero line intersect is susceptible to “whipsaws”, which implies that price could go above the line, and come below 100 in a blink of an eye.
It is important for traders to filter alerts on the grounds of the current trend.
For instance, if a currency pair is moving higher, only go long when the indicator dips below zero or 100 and then rises back above zero or 100.
Similarly, the momentum indicator can also dish out a sell signal when it falls below 100 or zero.
Our chart in Fig. 1.1 shows the momentum indicator confirming a bullish trend.
The 100 SMA indicator is seen below price bars, hence signaling an overall bullish trend.
We’ll then wait for the momentum indicator to fall back below the 100 (Zone B) and subsequently break above the 100 (Zone C), to confirm a bullish signal.
2. Momentum Crossover
Combine the momentum indicator with the moving average indicator.
A buy is triggered when the momentum indicator crosses above the moving average bottom up, while a sell is triggered when the momentum indicator crosses below the moving average top downward.
There are some inherent problems with this method, especially the false positives that they tend to yield, which can be avoided only if signals that are in the direction of the trends are considered.
In this vein, if the trend is bearish, only go for sell signals following the indicator’s motion above the moving average and then its subsequent dip.
Exit short positions when the indicator moves back above the moving average.
Considering that we have two indicators under study, it is wise to test out the different moving average periods and those on the momentum indicator to arrive at an arrangement that suits your trading style.
3. Momentum Divergence
When the price is seen to be moving downwards, but the lows seen on the momentum indicator are moving higher, a bullish divergence is in place.
This implies that while the price was going lower, the momentum supporting the selling pressure is easing.
If a buy alert pops up, this bullish divergence can confirm it.
If the price is surging higher, but the momentum indicator’s highs are dipping lower, a bearish divergence is in place.
This implies that while the price is surging, the momentum supporting the buying pressures is easing. If a sell alert is in the offing, a bearish divergence can help confirm it.
Momentum indicator divergence should not be deployed in isolation, as this is not reliable.
Use this method only as a confirmation tool based on signals from other strategies.
If you must deploy the momentum divergence technique, be cautious of false positives from the indicator.
For instance, if the price is surging strongly but then begins to show signs of choppiness, the momentum indicator will rise and then begin to dip.
This isn’t a bad signal.
The indicator is just depicting in an altered manner, what is visible on the activity chart: price displays a lot momentum and currently has very little (depleting momentum), but that doesn’t imply the price is going to depreciate.
Momentum Indicator trading strategies for scalpers
Momentum indicator trading strategies for scalpers can be deployed when we reduce the periods found within the indicator’s parameter setting.
Our preferred setting is 10, as such the indicator’s sensitivity is increased to give way for more signals.
Combining the momentum indicator with a trend indicator does increase its chances of confirming more profitable trades.
Playing around with such a setup will ramp up your likelihood of getting a desirable trade setup.
Check out an example here on momentum indicator trading strategies for scalpers.
Momentum Indicator trading strategies for day traders
Momentum holds the secret behind day trading.
The only way to make a profit off trading is to find currency pairs that are moving.
The good news is that almost every single day you’ll find currency pairs that move 1-2% or even more.
You need to find such forex pairs before they make such big moves.
Now currency pairs that exhibit choppiness are useless to day traders.
Traders can as well adopt the “Momentum Crossover” trading technique on higher timeframes i.e. 1-hour, 4-hour, 1-Day, etc.
See an example of momentum indicator trading strategy for day traders here.
Momentum Indicator trading strategies for swing traders
The strategy of buy-and-hold is critical to every swing trader.
The only area of contention is how long one should hold should positions.
Good timing is essential to profitability when swing trading.
Some traders will just go ahead to target just around 30-80 pips on every swing.
The 100 Line Intersect trading strategy can be deployed on the 30-minute, 1-hour and 4-hour trading chart.
See here an example of a momentum indicator trading strategy for swing traders.
The momentum indicator will not give you a lot of information over and above what can be merely viewed by just glancing at the activity chart itself.
If we see price moving aggressively higher, this will be viewed on the activity chart, as well as the within the momentum indicator window.
The momentum indicator can be used to spot silent changes in the buying and selling force although, largely via the use of divergence (but be wary of the false positives).
The momentum indicator is best deployed in combination with a price action setup, or a trend indicator, offering confirmation as opposed to deploying the indicator to create trade alerts in isolation.
The momentum indicator can tell us when and where we can initiate a trade.
Confirmation of such signals is crucial and if followed closely, the momentum indicator can produce higher profits, and even more, a relaxed trading state.