Momentum indicator, meaning it measures the speed and strength of price movement. It is considered one of the essential tools complementing directional indicators, and most analysts and traders in financial markets use it to generate buy and sell signals, whether in directional or sideways movements.
The idea of the indicator and how to use it:
The 'Momentum' indicator is the primary and main representation of all technical indicators related to measuring momentum, as it measures the rate of change in price movements.
If the trading range for a specific time period is higher than that of the previous time period, this is considered an increase in the rate of change, accelerating the price movement, and thus the indicator rises.
Conversely, if the trading range for the time period is lower than the range of the previous time period, this is considered a decrease in the rate of change, slowing down the price movement, leading to a lower reading on the indicator.
Momentum indicators work ideally when the market moves sideways and may not provide strong results in predicting price reversal points when the market is in a trending motion. Therefore, it is essential to consider the trend when dealing with this momentum indicator or any other types of momentum indicators.
Momentum indicator signals
Overbought and oversold
In general, momentum indicators reach a state of overbought when they reach a high level of price movement compared to previous peaks that the price formed, indicating that the market has currently exhausted its upward movement and is ready to drop, at least for a correction.
Momentum indicators reach a state of oversold when they reach a low level compared to previous lows, indicating that the market has currently exhausted its downward movement and is ready to rise, at least for a correction.
It should be noted that overbought does not necessarily mean that we should sell, and oversold does not mean that we should buy. The reversal movement could be a temporary correction, and the price may return to its previous trend. Therefore, following the context of the movement is very important before determining the entry signal.
Divergence
Most of the indicator's movements follow price movements, both upward and downward, and the occurrence of divergence means a difference between the movement of the indicator and the movement of the price.
The divergence signal is a reversal signal and is considered a leading indicator for price movements, as it predicts movement before it occurs. There are two types: negative divergence supporting selling, and positive divergence supporting buying.
Negative divergence, also known as selling divergence, occurs in upward movement when the price reaches a peak higher than the previous peak, while the indicator corresponds with a peak lower than the previous peak.
Positive divergence, also known as buying divergence, occurs in downward movement when the price reaches a low lower than the previous low, while the indicator corresponds with a low higher than the previous low.
Examples from the chart:
Generating buy and sell signals directly from the indicator:
In trending movement
Buy signal, when the trend is upward and the indicator drops below the midpoint line of 100 and then rises again.
Sell signal, occurs in a downward trend when the indicator line rises above the midpoint line of 100 and then returns below it again.
Breaking the drawn trend line on the indicator
The fluctuating movement of the indicator closely resembles price movements, often following them both upward and downward in conjunction with the peaks and troughs it forms. Therefore, one can benefit from trendline techniques to predict changes in price movement.
Let's observe together
Breaking the drawn upward trend line on the indicator always precedes the price movement turning from upward to downward.
Breaking the drawn downward trend line on the indicator always precedes the price movement turning from downward to upward.
