This is the third article in our Momentum indicator series. If you haven’t already, we suggest that you check out the first article about the Momentum Indicator. In the previous two articles, we have covered the background, the calculations involved, and how to use and read the Momentum indicator. The Momentum indicator attempts to measure the momentum behind price movements for the underlying currency pair over a period of time. Traders use the index to determine overbought and oversold conditions and the strength of prevailing trends.
Forex traders focus on the Momentum key points of reference, which are extreme highpoint and lowpoint values. As with any technical indicator, a Momentum chart will never be 100% correct in the signals that it presents, but the signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding Momentum indicator signals must be developed over time. In the example below, let’s develop a simple trading system based on Momentum signals and alerts.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “green” circles on the above chart illustrate optimal entry and exit points that can be discerned from using Momentum analysis in combination with the added Smoothed Moving Average, shown in “Red”.
A simple trading system would then be:
- Determine your entry point after the “Blue” Momentum line dips to a lower extreme and is followed by a crossing of the SMA “Red” line;
- Execute a “Buy” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” below your entry point;
- Determine your exit point after the Momentum reaches an extreme upper value followed by a crossing of the SMA “Red” line.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded one profitable trade of 110 “pips”, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, Momentum Technical Analysis will provide you with an “edge”.
That concludes our series on the Momentum Indicator. For further reading visit our Forex indicators section.
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