The “Momentum” indicator is another member of the “Oscillator” family of technical indicators. The creator of the Momentum indicator is unknown, but Martin Pring has written much about the indicator. It 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.
The Momentum indicator is classified as an “oscillator” since the resulting curve fluctuates between values about a “100” centerline, which may or may not be drawn on the indicator chart. Overbought and oversold conditions are imminent when the curve reaches maximum or minimum values. The addition of a Smoothed Moving Average with the indicator improves interpretation of imminent trend changes.
The Momentum indicator is common on Metatrader4 trading software, and the calculation formula sequence involves these straightforward steps:
- Choose a predetermined period “X” (Standard value is “14”, although a value of “8” or “9” tends to be more sensitive);
- Calculate “Close1” as the closing price for the current bar;
- Calculate “CloseX” as the closing price “X” bars ago;
- MOMENTUM = 100 X (“Close1″/”CloseX”)
Software programs perform the necessary computational work and produce a Momentum indicator as displayed in the bottom portion of the following chart:
The Momentum indicator is composed of a single fluctuating curve. Traders will occasionally add a Smoothed Moving Average, as above in “Red”, to enhance the value of the trading signals. In the example above, the “Blue” line is the Momentum, while the “Red” line represents a “SMA” for “14” periods. The Momentum is viewed as a “leading” indicator, in that its signals foretell that a change in trend is imminent. The weakness in the indicator is that timing is not necessarily a product of the Momentum, the reason for attaching a “lagging” moving average to confirm the Momentum signal.
The Momentum indicator is regarded as an excellent gauge of market strength. A shorter period setting will create a more sensitive indicator, but will also increase choppiness and the potential for increased false signals.
The next article in this series on the Momentum indicator will discuss how this oscillator is used in forex trading and how to read the various graphical signals that are generated
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