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Momentum Indicator

Indicator Name: Momentum Indicator

Indicator Type: Unbounded Oscillator

Description: The momentum oscillator has been in use for a long time. It is not known where and when exactly it originated. Its combination of simplicity and usefulness makes it quite likely that several early market technicians developed the idea independently of each other. Your charting package may have a slight variation on the original formula, but it will still be used in the same way. It should be noted that the momentum oscillator is a leading indicator, meaning that it gives signals before price action confirms them.

The momentum oscillator is unbounded, which means that it can technically go as high or as low as it wants - there is no maximum or minimum value.

Calculation: Being simple to use, simple to understand, and simple to calculate are the main attractions of the momentum oscillator. Here is how we go about calculating it:

How to calculate momentum indicator

Mx is the momentum
P is the last (current) bar's closing price and
Vx is the closing price from x bars ago.

We can easily see that our parameter x is the only thing we can vary. We will see later what the most common setting is. For now, let's look at an example. Say we are looking at a daily chart and the last 5 days closing prices are 100.00, 101.00, 102.00, 103.00, 106.00 and we are looking for M5, or 5 day momentum oscillator value. We simply take the last closing price (106.00) and subtract from it the closing price 5 days prior (100.00) and we see that M5=6.00.

We should note here that price was trending up, so our momentum value is positive. If price had been trending down we would have a negative value for momentum.

Uses: Like all oscillators, momentum is an attempt to calculate whether the current price has overshot to either the bullish or bearish extreme. Since momentum is unbounded however, we don't have an objective way to determine exactly how "overbought" or "oversold" the market is. What we can do instead, is look at historical data for the particular instrument we are charting, and determine suitable "overbought" and "oversold" areas based on past levels. The momentum indicator also usually has a zero line, where we can see that values above this mean an up-trending market, and negative values indicate a down-trending market. This gives us 3 possible trade signals: when the indicator starts to emerge downward from our selected overbought line (or flattens) we sell, when it emerges upward from oversold (or flattens) we buy, or we can also do the same when the indicator crosses the zero line.

Most Common Settings: 10 periods on daily charts is the most common setup for the momentum indicator. There are many other settings in use by traders however, particularly in forex where daily charts are not as significant as in other markets where there are specific daily open and daily close times. In forex, daily charts can sometimes be misleading depending on your broker's open/close times on the weekend, and your datafeed's timezone.

Strengths: Easy to use, powerful indicator. Perhaps its best known strength is the fact that it is a leading indicator, meaning that it often foresees changes or continuations in trend before price action alone suggests it.

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