What is the Momentum in technical stock market analysis?
The Momentum is one of the best known oscillator indicators in the world trading markets, whether of stocks, futures, Forex or even cryptocurrencies.
This indicator measures how the price of an instrument varies over a period of time. Therefore it is an indicator that works with the so-called English ROC (rate of change = exchange rate).
How is momentum calculated?
Momentum = today’s close – close N days before
Although to be a better graphic we could do the following:
Momentum = (today’s close / close of N days before) * 100
With this we will have a value that will normally hover around the value of 100 and is the type of data that we will see in Metatrader 4, for example.
Today’s price: 200
Price of 10 days ago: 220
Momentum = (200/220) * 100 = 90.90
In this case we get a negative momentum.
If the price of 10 days ago is lower, type 180, then:
Momentum = (200/180) * 100 = 111.11
In this case we get a positive momentum.
The exchange rate or ROC could look like this:
ROC = (today’s close – close N days before) / close N days before
Although with the momentum calculation as I put in the example we have enough.
As we can see it is a very simple indicator to calculate which will be positive if today’s closing price is higher than that of N previous periods and negative in the opposite case.
The example given is for the type of graph that I will use mostly in this article, in this case the Metatrader 4.
In other cases, from other brokers or other graphics platforms, we have another type of calculation.
For example, in the Tradingview charts we have the gross calculation, as was the first equation that I put, so that if we have a price of 200 today and that of 10 days ago 220, the indicator would give us 20, which as you can see is different at 90.90 when we “soften” it in a percentage way.
How do we interpret the Momentum indicator?
First of all we are going to comment something important that has to do with the name itself: “momentum”.
This term refers to the Spanish “moment”.
With this we can already intuit that it is an indicator that tries to give us clues about how the price is entering significant moments, with significant changes in it, hence supposedly those moments we are going to choose to operate.
In this way we could say that with the momentum we will try to find those trend movements so sought after and loved in the world of trading and investment.
The key is to capture when the market is changing its price strongly, that is, it is in “momentum” mode.
Well, is it easy to apply this strategy to win?
What is involved with the Momentum is to try to win when the market goes down or when the market rises, because we will try to use the benchmark: 100 to make upward or downward entries when the market rises or falls from it.
Mind you, we can also try counter strategies.
Not everything is to follow the theory that is explained to us everywhere.
In fact, we can apply different approaches; as many as ideas we have in our heads.
For example, instead of using point 100 as a reference, we could use 105 or 102 and only make operations when the price crosses that level.
The thing here, as always in the world of indicators, is “complicated” ad infinitum, so you will not get bored when looking for possible innovative approaches, for which, believe me, with the momentum you would have for a while .
If we realize one thing, before applying momentum strategies we have to see in which trading period we are trying to apply them.
A 5-minute bar chart is not the same as one of weekly bars.
Because as you can understand in a small bar graph the price variations will be minimal, while the price variations in a weekly or daily candle chart will be depending on the asset, much stronger.
We can see an example here with the SP500.
If we use the 5-minute candle chart we will hardly have variations around 100.
In the case of daily candles we can see that variations around 100 are 30 times or more higher than that of the previous case. Here we go looking for bigger movements, obviously.
The case of the candles of small periods is more applied to those who do day trading, which requires, then from another point of view.
Periods to be chosen in the Momentum indicator
Another interesting point of this indicator is the number of periods to choose to calculate the variation with respect to it.
The general opinion of the experts and of the majority of articles that you find on the web, both in Spanish and English, is that it seems that using small values, such as 8, 10, or the typical, 14, is better because they are more “sensitive”. In fact, the smaller “more sensitive”.
Now, that which is better because it is more sensitive does not have to be true.
It will have to be verified.
In my case, if I have to tell you something from the point of view of the experience, it is that a lot of “sensitivity” is not good in trading.
Rather, we would obtain fewer operations but more clearly if we decrease this sensitivity.
This is a problem because doing so decreases the number of operations and so on, which is not liked by brokers or market commissioners.
But the truth is that: if you start doing excessive operations, you’re sure to take a lot of genuinely good moves, but you’ll also swallow all the “noise” of the market, and in the market, my friend, I’ll tell you that the amount of noise is huge.
By this I do not mean that we have to operate with Momentums and periods of 500 days, but if we move away from those periods of a single figure, type 7, 8, or even those of 14, 20 or 28, we will give a step in the direction of improving the quality of our operations: that is, to operate less, but better.
As always you will have to look for a period of time that suits you, for which you will have to study your own systems and see what is best suited to you and your situation.
Momentum for day trading
This indicator is used, of course, in day trading, either manually or automatically, with the second method, as we know, very upwards in recent years.
Well, as I said with this indicator we are going to have a very small variation in the price around 100.
This is so because with graphics of 1, 5 or 15 minutes we will have few variations in the price.
For example, in a typical Forex market, we can expect price variations of 1 or 2%.
This 1 or 2% can give you a clue as to how the momentum number will turn out.
If the price moves 1% with respect to the previous N period, then our momentum will be 99 or 101, with which we can clearly see that this indicator is a measure of the change in the price in percentage terms.
If the candles are monthly, this variation can be expected to be 20, 40 or 60%, with what we would expect to see a figure that would vary between 80, 60 or 40.
Despite this day traders say that this does not matter because in the end what matters is the idea behind the indicator and if it moves between 98 and 102 it does not matter if it moves between 50 and 150, because in the end what they are looking for quality trading signals upwards or downwards regardless of the timing.
That’s fine, in theory.
Both graphs, the 5-minute bar and the daily bars, seem to teach us that the market moves, crosses those lines and therefore gives us potential signals.
Now, as I always say, the problem of day trading lies in the following question, which in turn is related to what I said before:
The problem of day trading is that with it we will make all or almost every day, with what in the end we will be negotiating in all that time that I previously called “noise”, which can be months of meaningless trading, in which the thing behaves almost randomly, with a meaningless struggle between bulls and bears.
This problem is very difficult to solve, and those who want to dedicate themselves successfully to day trading will have to look for strategies that take into account this type of issues.
In long-term trading, with candles for one day, things change, because we already have noise days affecting less, especially if we are able to avoid trading in them.
Conclusion about momentum
This is an indicator that I like for a simple reason: its simplicity and because it is similar to the price in the way it moves.
This, together with its very clear calculation parameters, is beneficial for applying clear trading strategies in which “only” we will have to refine other variables that are no less important, of course.
The important thing is to choose the entry points well and for this, this indicator gives us a good reference.
I prefer it to other indicators more “cloudy” (confused) so to speak.
Regards and good trading.
Original article: Qué tal funciona el indicador momentum