Momentum
Momentum
measures the speed of price change and provides
a leading indicator of changes in trend.
Overview
- The Momentum
line leads price action frequently enough
to signal a potential trend reversal in
the market.
- Momentum indicators
can warn of dormant strength or weakness
in the price well ahead of the turning point.
- At extreme
positive values, momentum implies an overbought
position; at extreme negative values, an
oversold position.
Interpretation
A strongly
trending market acts like a pendulum; the move
begins at a fast pace, with strong momentum.
It gradually slows down, or loses momentum,
stops, and reverses course.
The
momentum line is always a step ahead of the
price movement. It leads the advance or decline
in prices and levels off while the current price
trend is still in effect. It then begins to
move in the opposite direction as prices begin
to level off.
The
10 day momentum line fluctuates on an open scale
around a zero line. When the latest closing
price is higher than that of 10 days ago, a
positive value is plotted above the zero line.
If the latest close is lower than 10 days previous,
a negative value is plotted.
Ten
days or periods are usually used in calculating
momentum, but any time period can be employed.
The shorter the time frame used the more sensitive
momentum becomes to short term fluctuations
with more marked oscillations. Oscillator swings
are smoother and more stable when a longer number
of days are used.
Upward
Momentum
When
an uptrending momentum line begins to flatten
out it means that the new gains being achieved
by the latest closing prices are the same as
the gains 10 days earlier. The rate of upward
momentum has leveled off even though prices
may still be advancing. When the momentum line
begins to drop further, below the zero line,
the uptrend in prices could still be in force,
but the last price gains are less than those
of 10 days ago. The uptrend is losing momentum.
Downward
momentum
When
the momentum line moves below the zero line,
the latest close is now under the close of 10
days ago and a short term downtrend is in effect.
As momentum continues to drop farther below
the zero line, the downtrend gains momentum.
The downtrend decelerates when the line begins
to turn around.
If loss
of momentum is experienced in a market at the
same time as selling resistance is met or when
buying power is temporarily exhausted, momentum
and price peak simultaneously.
Signals
Momentum
is a basic application of oscillator analysis,
designedto measure the rate of price change,
not the actual price level.
Three
common signals are generated by the momentum
oscillator: zero-line crossings, trendline violations,
and extreme values.
Zero-line
crossings
Although
the long-term price trend is still the overriding
consideration, a crossing above the zero line
could be a buy signal if the price trend is
up and a crossing below the zero line, a sell
signal, if the price trend is down.
Using
Trendlines
The
trendlines on the momentum chart are broken
sooner than those on the price chart. The value
of the momentum indicator is that it turns sooner
than the market itself, making it a leading
indicator.
Extreme
Values
One
of the benefits of oscillator analysis is being
able to determine when markets are in extreme
areas. At extreme positive values, momentum
implies an overbought position; at extreme negative
values, an oversold position
The
absence of a fixed upper and lower boundary
presents a difficulty with the momentum line.
To help solve this problem look at the long-term
history of the momentum line and draw horizontal
lines along its upper and lower boundaries.
Adjust these lines periodically, especially
after important trend changes.
