Momentum is a widely used financial indicator because of its extreme simplicity and intuitiveness. Its primary purpose is to assess the speed of price movement in trading.
Momentum: how it works
The formula for this financial indicator is essentially based on past data, as for most oscillators, taking into account the continuous variations in price over predetermined time intervals.
To construct the ten-day Momentum line, which is the most recurrent, it is necessary to subtract the closing price of ten previous intervals from the last price marked.
The formula is the following:
M = V – Vx
where V indicates the closing price while Vx the price from ten days before.
In even simpler words, the Momentum is nothing more than the difference between the price of today and that of X days ago.
This indicator can take both positive values (if the current price is higher than the past price) and negative values (if the current price is lower than the past price).
Unlike other oscillators, such as RSI, which moves within a range, the Momentum has no lower or upper limit. A zero line helps in understanding at what stage the market is.
Using a shorter period of time may result in more false signals and more pronounced oscillations, whereas using a longer period of time will generate a more blunt line with less fluctuating oscillator waves.
Momentum: the signals generated
The zero line is the one to take into consideration during trading as it is the one that allows the Momentum to generate signals.
In particular, a bullish signal will be generated when switching from negative to positive.
Conversely, if there is a change from positive to negative, a bearish signal will be generated.
In principle, the Momentum tends to follow price movements. When a maximum price is reached it will correspond to a maximum of the indicator.
When this does not happen, there is a divergence between the two elements. In this situation, a downward price retracement will be expected, confirming the weakness shown by the Momentum. The same applies to minimums.