Forex momentum indicator strategy

One principle of the momentum indicator strategy is, “buy high to go higher” and “sell low to go lower.” In other words, we trade in the direction of the trend while having the momentum on our side. Also read the hidden secrets of moving average.
Table of contents

• How To Trade Momentum In Technical Analysis -
• Momentum Indicator (MOM)
• Applying the Indicator to Your Chart
• Short term vs. long term momentum

Momentum reflects the velocity of price changes and is calculated as the difference between the current bars price and the price a selected number of bars ago. It simply shows the rate at which the price of the trading instrument changes during the specified period of time. The faster the price surges, the more momentum will increase. The faster the price drops, the more momentum will decline. If prices begin changing at a slower rate, momentum will also slow down and return to a more normal level.

First, crossing over the zero line. In case the Momentum indicator crosses above its zero line, this is considered as a signal to buy. In case the Momentum indicator crosses below its zero line, this is considered as a signal to sell. When there are assets of this nature, this can create price bubbles or very erratic trading behavior. At the same time, there is a lot of polarity among traders and investors on how to use momentum.

The thinking behind it can be analogized as follows. If a car is accelerating from being completely idle, its acceleration rate of change of velocity is getting higher but its velocity is still low. This would be akin to a security whose momentum is increasing but its price has yet to move too materially in one direction or another. At some point during the trip, the car will stop accelerating and it will be at this moment that it is moving the fastest.

This is the equivalent to when price will be moving the fastest in a security. The momentum indicator should be paired with another tool to help filter false signals and improve their statistical accuracy.

For this purpose, we can pair it with another price reversal indicator. The Keltner Channels, as explained in more depth in this article , use the touch of the top and bottom bands in order to find areas where price could be statistically likely to reverse. But first we need to establish what these rules are.

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We can keep this six-point spread symmetrical based on trend. For an exit signal on long trades, we can take a touch of the period simple moving average SMA or a move below on the momentum indicator.

Applying the Indicator to Your Chart

For an exit signal on short trades, we can take a touch of the period SMA or a move above 94 on the momentum indicator. On the very left side of the chart, there was an upward breach of on the momentum indicator but no concomitant upward touch of the Keltner Channel.

But we finally see both occur later on, marked by the first vertical white line that extends across both charts. The horizontal lines show the price levels of the trade and show a decent profit for the short trade taken as part of the rules associated with this system. We need a break of momentum above or below 94 , a touch of the top band of the Keltner Channel or touch of the bottom band , and either a drop of momentum back into the range or touch of the period SMA.

Again, the horizontal line on the momentum indicator bottom chart represents the level. The first vertical line on both charts represents the instance where our criteria was satisfied resulting in a short trade.

Short term vs. long term momentum

The second vertical line denotes trade exit due to a touch of the period SMA. The horizontal line on the top chart show the entry and exit prices. This trade made a slight profit. A momentum potential buy signal occurs when the Momentum indicator crosses above the zero line. The crossing of the zero line implies that the price of the stock, future, or currency pair is reversing course. Either by having bottomed out or by breaking out above recent highs; this is typically viewed as a bullish signal.

Alternatively, you have a momentum potential sell signal when the momentum indicator crosses below the zero line. Generally speaking the potential buy and sell signals discussed above are poor exits, either selling out of a long position or buying to cover a short position. By the time the Momentum indicator returns back to the zero line, most or all of the profits have probably eroded, or even worse the trader has let a winning position turn into a losing position.

When the Momentum is reversing course and is heading back towards the zero line, that means profits have been eroded. How much of a retracement back towards the zero line before an exit is triggered is up to the trader. Another possible alternative is to draw a trendline; when the trendline is broken, that might act as the exit signal. Potential buy and sell signals are not the only use of the Momentum indicator. The next page discusses using Momentum to detect divergences, an important trading concept. Identifying divergences between price and technical indicators can be an important aspect of technical analysis trading.

Bullish divergences might signal a trader to exit their short position; similarly, bearish divergences could warn that prices could correct and that it might be advisable to exit any longs.

The first bearish divergence occurred when price formed a double top formation.