Top Momentum Indicators: In the financial markets, trading success often depends on the ability to identify market strength and direction. Momentum indicators, an important tool under technical analysis, empower traders with valuable information about the strength and direction of the price movement in securities. These indicators help traders build a potential view of market momentum for a better understanding of entry and exit points.
In this article, we shall explore the top momentum indicators with charting examples that most analysts and traders use, to make informed decisions.
Top Momentum Indicators
Relative Strength Index (RSI)
The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. RSI is generally used to identify the over-bought and over-sold zones in the market. It can also indicate a trend reversal and buy/sell signals. It is typically calculated by considering the average of gains and losses over a certain period and it oscillates between a range of 0 to 100.
Overbought/Oversold Zone
When the RSI oscillator moves above line 70 (on a scale of 0 to 100), then the zone is considered to be an overbought zone. when the oscillator moves below line 30 then the zone is considered to be oversold. When the indicator moves below the over-bought line (70 zones), a short position can be initiated, or when it moves above the over-sold zone (above 30), a long position can be placed.
Divergence with RSI
Divergence occurs when the price is trading in the opposite direction to the signal provided by the RSI indicator.
Bullish divergence:- It is formed when the price of security makes a lower low, but the RSI indicator is diverging by making higher lows. It indicates a possibility of upcoming bullish momentum.
Bearish divergence:- It is formed when the price of security records a higher high, but the RSI indicator forms lower highs. It indicates a possibility of bearish momentum.
Moving Average Convergence Divergence(MACD)
MACD stands for Moving Average Convergence Divergence which is a momentum-based trend-following indicator.MACD indicator consists of a MACD line, signal line, and histogram that is based on the moving average of securities price. where
- The MACD line and the signal line indicate entry and exit opportunities in the price of a security.
- The histogram represented over zero line indicates bullish and bearish momentum present in the security.
MACD– Crossover strategy
The MACD line and the signal line crossover indicate possible entry and exit opportunities in security. When the MACD line crosses above the signal line, it indicates a buy signal and one can enter a long position in the security to capture upward movement. Also, traders can book the profits in a short position when the MACD line crosses below the signal line.
When the MACD line crosses below the signal line of the indicator, it indicates a sell signal and one can enter a short position in the price of a security to capture the downside movement. Also, traders can book the profits in a long position when the MACD line crosses above the signal line.
MACD – Moving Average
The moving average is a momentum-based technical indicator calculated as an average of the past closing price of the security over a specific period. It is a commonly used analysis tool to easily identify price trends, support & resistance levels with buy/sell signals. The moving average indicator can be calculated for any period (5 days,9 days,50 days,200 days, and so on) based on short-term or long-term trading strategies.
Direction with Moving Average
When the price of security closes above the moving average, it is considered to be an uptrend. Here, traders can enter a long position (or hold their existing long position) in the security. Also the moving average acts as a support to push the prices higher and one can exit the position if the price closes below the moving average line.
When the price of a security closes below the moving average it is considered as a downtrend. Here, traders can enter a short position in a security. The moving average acts as a resistance to pull the prices lower, and if the price closes above the moving average then the short (or sell) position should (or could) be squared off.
Average Directional Index(ADX)
The Average Directional Index is a tool that is used to measure the strength and direction of a trend in a security. ADX indicator comes with three lines, the blue line is the ADX line where its values define the strength of the trend, and the higher the ADX value, the stronger the trend.
The green line is the positive directional movement index(+DM), which gauges the strength of the upward price movements. Higher values of +DM indicate a higher price movement. The red line is the negative directional movement index (-DM), which measures the strength of downward price movement. It is opposite to the green line.
ADX Indicator parameters
- When ADX is less than 25, then it indicates an accumulation or distribution phase.
- When the ADX is greater than 25, it indicates a fair strength in the trend direction.
- When the ADX value is greater than 50 it indicates a strong strength in trend direction.
Bullish Crossover
when the positive directional movement index(+DM) line crosses above the negative directional movement index(-DM) line, it indicates that the rate of positive price change for the security is greater than the rate of negative price change.A crossover confirmed by ADX value above 25 levels indicates a strong strength to enter a long position.
Bearish Crossover
When the negative directional movement index(-DM) line crosses over the positive directional movement index(+DM) line, it indicates that the negative rate of price change is higher than the positive rate of price change.If the ADX line is above the 25 mark and trending, then it is a strong sell signal.
Stochastic Oscillator
The stochastic oscillator is an indicator used to measure the momentum of a security. The oscillator compares the closing price of a security to its price range over a specific period. It oscillates between 0 to 100. The indicator was developed based on the fact that a change in momentum happens before a price change, which helps to identify the overbought/oversold zone, trends, and price reversals.
Overbought/Oversold levels
When the stochastic oscillator ranges between 80 to 100, it is considered as the overbought zone, and here one could look for an exit of the long position and entry to the short position of security. When the oscillator oscillates between the range of 0 to 20, the price of the security is considered to be oversold and here the opportunity for a long position can be looked out for and the short position can be squared off.
Divergence
Divergence is the disagreement between the price of a security and the technical indicator movement.
Bullish Divergence:- A bullish divergence occurs when the price of the security makes a lower low and the stochastic oscillator makes a higher low, which indicates that the downside momentum of the price is gradually decreasing, and upside price movement could be requested soon.
Bearish Divergence:- In a bearish divergence, the price of a security makes a higher high while the stochastic oscillator makes a lower high, indicating the upward price momentum is slowing down. Here, it can be understood that the security is ready for a downtrend.
Conclusion
From the above learnings, it is clear that knowing momentum indicators is a great advantage for traders to analyze the markets in a better way. The above-listed indicators have their success rates so it is important for traders to practice and backtest the strategies for a better understanding of their application. Also, it is always preferred that the strategy should be used in conjunction with other technical tools for better-confirmed trading entries to avoid false signals.
Written By Deepak M
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