J. Welles Wilder created the index in the late 1970s and wrote about the price momentum and the RSI in the classic book New Concepts in Trading Systems. From the standpoint of trading, momentum is a very useful indicator of strength or weakness in the issue’s price. Momentum indicator is very reliable on its own, but what would happen if we decided to combine it with other technical analysis tools? History has shown that momentum is far more useful during rising markets than during falling markets. The momentum indicator is used provide trade signals and to confirm the validity of trades based on price actions such as breakouts or pullbacks.
The best binary option broker platform Pocket Option offers a wide range of indicators, oscillators and other technical tools to the traders so they can trade with confidence and make informed decisions.
How to calculate the Momentum Indicator?
It is easy to calculate momentum indicator by taking price differences for a fixed time interval. To construct a 10-day momentum line, simply subtract the closing price 10 days ago from the last closing price. The first version simply takes the difference between the two closing prices. The second version calculates momentum as the rate of change in the price and is expressed as a percentage. The positive or negative value is then plotted around a zero line.
When you activate the Momentum Indicator, it will display it under the chart in a separate window. It appears like a moving average and horizontal levels:
Basically, how the far the indicator is above or below zero or 100 indicates how fast the price is moving. For the first version, a difference of 0.35 means there is more upside momentum than a difference of 0.15. For the second version, a momentum of 98 percent shows the price is moving down with more force than a momentum of 99 percent.
The default setting for the Momentum Indicator in the Pocket Option terminal is a timeframe (n) equal to 10. However, some experts recommend changing this value to 14. To adjust the settings, click on the pencil image next to the indicator and change the setting.
When the price crosses above or below the 100 line (or the zero line if the indicator in a chart is based on the first type of calculation), it can represent a buy or sell signal respectively.
If the price crosses above the 100 line, the price is starting to gain momentum higher. A drop below the 100 line shows the price is losing momentum.
Buy when the momentum indicator crosses above the moving average from below and sell when the momentum indicator crosses below the moving average from above.
Remember, that this strategy has its problems, too, mainly that same whipsaw issue. That problem can be somewhat alleviated by once again responding only to trade signals in the trending direction. In this case, if the trend is down, make a short trade only after the indicator has moved above the moving average and then drops below. Exit the short trade when the indicator moves above the moving average.
How to trade with Momentum?
The momentum indicator isn’t going to provide much information beyond what can be seen just by looking at the price chart itself. If the price is moving aggressively higher, this will be visible on the price chart as well as on the momentum indicator.
The basic idea is to buy when the momentum line crosses the Moving average from below, and sell when the momentum line crosses the Moving average from above. This by itself would be a very rudimentary application, but we can enhance these types of signals by taking trades only in the direction of the underlying trend or taking signals only after an Overbought or Oversold condition has been met.
- CALL when the signal line crosses the level 100 from the bottom up.
- PUT when the signal line crosses the 100 level from top to bottom.
The timeframe should not exceed the formation time of 4 candles.
The beauty of using this oscillator is that it is equally effective on all timeframes and with any asset. Therefore, it can be used both in turbo options trading and for longer expirations
The momentum indicator can sometimes be useful for spotting subtle shifts in the force of buying or selling. The indicator is best used to help provide confirmation of a price action trading strategy, as opposed to using it to generate trade signals on its own. As we have discussed, there are many trading signals that can be generated with the Momentum Indicator including the 100 Line Cross, the Momentum Crossover, and the Divergence signal. Remember, regardless of type of Momentum signal you employ, it is highly recommended that you combine technical tools in your strategy.