Spark Global Limited Reports:
Many of the best day traders in the world use momentum indicators and outperform each year.
Momentum traders believe that the market is correct and that stocks that have shown a recent upward or downward trend will continue to do so. To sum up what traders often say: “The trend is your friend.”
Momentum measures have the advantage that they are applicable to all markets, simple to use and easy to replicate. Thanks in part to these metrics, many successful traders have made or continue to make substantial profits.
In the following paragraphs, we will discuss momentum indicators, including what they are, how they are used, and other things.
What is momentum indicator (MOM)?
A momentum indicator is a tool used by traders to determine the momentum of a financial instrument (stocks, options, futures, currencies, etc.) as the market rises or falls.
Simply put, a momentum indicator compares the current price with prices prior to a given period.
In his book Technical Analysis of Financial Markets, John J. Murphy, a former CNBC technical analyst, says that “market momentum is measured by taking price differentials continuously over a fixed time interval.”
Murphy went on to say that to construct a 10-day momentum line, you simply “take the last closing price minus the closing price of the previous 10 days.” The positive and negative values are drawn around a zero line.”
Thus, while traders can use a number of charting software tools and trading platforms to calculate a stock’s momentum, the simplest way to calculate momentum is as follows:
Momentum =(close of current period)- (close of N cycles ago)
N = number of cycles selected by the trader
Important momentum indicator for day traders
While there are plenty of momentum indicators you can use, we’ve picked some widely used and very popular day traders.
Rate of change is a mathematical concept that shows how one value changes relative to another. Traders use this momentum indicator to compare price changes.
Relative Strength index (RSI)
The relative strength index was developed by Welles Wilder in the 1970s. The technology analyst lays out his calculations for this metric in his book new Concepts for Technology Trading Systems.
The RSI is considered a momentum indicator because it compares current price changes with recent price changes. The higher the reading, the faster the price changes.
Moving average convergence divergence
The moving average of convergence is an indicator that hovers near zero. It is a measure of momentum and trend.
The calculation of this indicator follows the same logic as the simple moving average, but incorporates additional features to provide a better view of the newer moving average than the older one.
When the indicator enters positive territory, traders take it as a buy signal; When the indicator enters negative territory, it is considered a sell signal.
Trend-tracking traders often use this indicator to supplement other technical analysis tools, rather than as a stand-alone indicator.