Making Money with Momentum
Many investors will confuse a trendline with momentum. However, as an event derived from astute technical analysis, Momentum tells investors a lot more than a cursory glance at a security price’s trend line. Using technical analysis and technical events like Momentum, investors are able to determine whether a price is likely to continue its trend or reverse and head the other way.
Understanding Momentum In some ways, Momentum is very similar to the MACD oscillator as it measures how much change a security’s price has seen over a predetermined period of time. Understanding how technical analysis works on an unbiased, statistical level as well as using Momentum will allow investors to determine whether a systemic change in price is part of the normal up-and-down of the market, or if it is instead a strong bearish or bullish signal. Essentially, Momentum tells us whether a given price trend will continue or reverse.
Put another way, Momentum gives investors insight into the underlying price trend. When using technical analysis tools in this manner, investors should be able to better identify whether a particular security is overbought or oversold and make changes to their positions accordingly. Decisions like these are impossible to make when based entirely on security prices.
Calculating Momentum One of the downfalls with technical analysis is that there is a heavy mathematical component to many of the events. While this not entirely true for Momentum, investors will need to understand the basic formula required to obtain a Momentum reading. Simply, Momentum is calculated by dividing the Closing Price by the Closing price ten periods ago, and multiplying it by 100. [Close/(Close 10 time-periods ago) * 100].
Trading on Momentum Basing trade decisions on Momentum is quite simple. If the Momentum value is greater than zero, then a bullish signal is trigger; less than zero, a bearish signal is triggered. Investors should, however, be cautious in that extremely higher low values might not suggest a reversal but instead a continuation of the existing trend. For example, where investors are looking to sell, instead of trading on Momentum, investors should wait for the actual security price to begin its fall before committing to selling.
In fact, with most signals derived through technical analysis, investors are advised to use other signals or patterns to confirm or refute a trade opportunity. Momentum is often used to confirm other events or price trends.
Despite Momentum being a fairly simple even to calculate, combining it with a dozen or more other events can become burdensome. Most investors rely on trading software to calculate buying opportunities based on technical analysis. Some trading software will even make simple buy and sell recommendations. While understanding technical analysis is important, completing the work yourself is not.
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