Momentum Concept and Indicators in Forex

The momentum concept comes down to trading with the trend — one of the most profitable ways to trade. If you use the simplest trading strategies and trade with the market’s general direction, you’ll very likely end up in profit. What sets trend-following strategies that factor in momentum apart is their ability to measure the current strength of a price move. So what is the momentum concept? How do you measure it? And what are momentum indicators? We’ll cover all of that in this article. It helps to understand Most Used Forex Trading Indicators.

The Momentum Concept

Momentum trading: buying and selling assets based on the strength of the most recent trend — checking whether there’s enough force behind the move, or whether it’s a false move and the trend is about to reverse.

What Are Momentum Indicators?

Momentum indicators: tools traders use to get a better read on how fast prices are moving.

Advantages of Momentum Indicators

• Momentum indicators show price movement over time and how strong those moves are, regardless of whether price is heading up or down.
• Momentum indicators help traders and technical analysts spot the key points where a price reversal is likely, through divergences between price action and momentum.
• Momentum indicators show the strength of a price trend but aren’t precise about direction, so it’s best to combine them with other technical indicators such as moving averages, or with classic technical-analysis strategies, to pin down direction.

Understanding Divergence

Divergence happens when a security’s price moves in one direction while the momentum indicator moves the opposite way. If price and the indicator move together in the same direction, that means the trend is backed by momentum, there’s no divergence, and the trend is very strong.

The chart below shows the divergence between price action and the Relative Strength Index (RSI) on the AUD/USD pair.

Divergence is usually a sign that the current price trend is likely to end and is close to reversing. When price moves down while the indicator moves up at the same time, that’s bullish divergence. If price and the momentum indicator keep moving up together and the indicator suddenly turns down, that’s bearish divergence.

Momentum Indicators

There’s a wide range of momentum indicators traders can use. In this article we’ll cover three of the best trading indicators used to measure momentum.

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1. MACD (Moving Average Convergence Divergence)

• MACD is one of the most widely used momentum indicators. It combines two moving averages and turns them into an oscillator by subtracting the longer average from the shorter one. That means MACD reflects momentum as it swings between the moving averages as they converge, cross, and pull apart from each other.
• As mentioned above, MACD uses two moving averages — a 12-day EMA and a 26-day EMA. Subtracting the 26-day EMA from the 12-day EMA gives you the MACD line. Next to the MACD line sits a 9-day EMA that acts as a signal line and can flag shifts in price action.
• The really important part of MACD is the histogram, which shows the gap between the MACD line and the signal line.

2. Relative Strength Index (RSI)

The Relative Strength Index (RSI) is also a popular momentum indicator. RSI works as a gauge of price changes and how fast they’re happening. It oscillates between zero and 100. Traders and analysts can read momentum from RSI easily: rising RSI values above 50 point to positive uptrend momentum, and once RSI reaches 70 or higher it’s often a sign price has hit overbought territory. On the other side, RSI readings dropping below 50 show negative momentum in a downtrend, and readings below 30 signal price has reached oversold territory.

3. Average Directional Index (ADX)

Finally, there’s the Average Directional Index (ADX), developed by the well-known technical analyst Welles Wilder.
The ADX is made up of three main lines:

• The directional index itself, ranging in value from 0 to 100, but it doesn’t show direction.
• The positive directional indicator (+DI), which reflects the difference between two consecutive highs.
• The negative directional indicator (-DI), which reflects the difference between two consecutive lows.

The indicator is part of the directional movement system, which works as a gauge of trend strength regardless of price’s current direction. Readings of 20 or higher point to a trend. Any reading below 20 and the market is seen as “trendless.”

Conclusion

So the momentum concept is the rate of acceleration in a security’s price — how fast the price is changing — and trading built on the momentum concept is a strategy that tries to profit from momentum by entering a trend while it’s gaining strength.

The momentum concept refers to the tendency of a price trend to keep moving, either up or down, over a given period, usually factoring in price and volume data in technical analysis. Momentum is often measured through specific indicators and used to help identify trends. Here are the key points on using the momentum concept in trading:

• Momentum indicators are essential tools for traders and analysts, but they’re rarely used alone. It’s common to pair them with other technical indicators that reveal trends — once a trend is identified, momentum indicators become valuable for gauging how strong that trend is.
• Momentum indicators aren’t limited to the three covered above, but these are considered the best and most popular among traders.

Read more:

• Time Analysis | What Are Time-Price Angles?

Frequently Asked Questions

What is momentum in trading?

Momentum measures the speed of price changes, calculated by continuously taking price differences over a set period. To build a 10-day momentum line, you’d subtract the closing price from 10 days ago from the most recent closing price.

How is the momentum indicator used in forex trading?

When the momentum indicator’s signal line reads as a positive number, price is in overbought territory; when it reads as a negative number, price is in oversold territory.

What’s the best momentum indicator for forex?

Among the most popular and effective momentum indicators are the Relative Strength Index (RSI), the Moving Average Convergence Divergence (MACD), and the Momentum indicator built into the MetaTrader 4 and 5 platforms.

Is momentum trading a good strategy?

Momentum trading is meant to be a higher-risk way of putting capital to work in the stock market. It’s definitely a form of trading, not investing — momentum trading can be a good way to make money when things go as your strategy expects, but it can also quickly lead to big losses if things move the other way.

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