Getting to Know Momentum
When it comes to security price momentum, many people will look at the general trend of a security without fully understanding the technical basis of the term. What Momentum really tells us, however, is whether the trend will continue or reverse. Without technical analysis and events like Momentum, many investors would buy high and sell low.
Defining Momentum Sharing similarities with the Moving Average Convergence-Divergence (MACD), Momentum tells investors how much a security’s price has changed over a certain time period. Investors with a general understanding of technical analysis methods, and this method in particular, will be able to more accurately determine whether day-to-day changes in price are merely a reflection of a market’s systemic behavior or if it is signaling a more permanent trend.
More specifically, Momentum tells investors about the strength of the underlying price trend. Using this type of technical analysis allows investors to determine overbought and oversold conditions in a security and decide whether opening or closing a position is called for. Such decisions are normally impossible to make based on security prices alone.
Calculating Momentum For do-it-yourself investors, completing your own technical analysis can be burdensome thanks to the often complicated mathematical demands needed to pinpoint events and patterns. With Momentum, the math is not all that difficult or involved. Simply, to arrive at a Momentum reading, you take the security’s close price and divide it into the close price 10 periods ago, and then multiply it by 100. Or: Close $ /(Close 10 time-periods ago) * 100].
Trading on Momentum When it comes to executing trades based on Momentum, the reading is quite simple to understand. Values above 0 are bullish and values below 0 are bearish. A word of caution however is that extremely higher low values might suggest a continuation of the existing trend. In the case of a sell, investors are urged to trade only if prices peak and then begin to fall and not trade before they begin to fall.
As with most technical analysis, investors should never base entry or exit points solely on Momentum. In many cases, Momentum can serve as confirmation of other technical events or even underlying security fundamentals.
Since Momentum and many other events triggered by technical analysis rely heavily on mathematical calculations, trading software is recommended for the individual investor. Such software can monitor many different technical trends and some of the more advanced system will make buy and sell recommendations.