What Are Momentum Indicators in Forex
Momentum indicators measure how strong the price change is in the currency pairs. This, in turn, helps in identifying market trends based on which traders can place long or short trading orders. In our article, we will learn about momentum indicators and how you can trade them in depth.
What are momentum indicators?
Momentum indicators are technical tools that can analyse the speed at which the currency pair prices change in the forex market. It allows traders to open positions after assessing the strength of the price moment and the market direction.
Advantages of trading with momentum indicators
- Irrespective of the direction in which the prices are moving, momentum indicators are able to show the price movement’s strength in the forex market.
- They help in spotting reversal points in the market.
- It helps leverage market volatility to the trader’s advantage by selling at high and buying at low.
- It measures the rate at which the currency pair prices fluctuate and provides entry/exit signals accordingly.
- They can be used with several other indicators to confirm market signals.
What is momentum trading?
Momentum trading refers to the process of buying and selling currency pairs in the market with the help of momentum indicators as per the recent strength of price movements. It tells traders that if there is enough momentum in the price movement, then there is a possibility of the market moving in the same direction, and traders can open positions in favour of the market. During an uptrend, when prices are trading at a high level, it attracts more and more buyers, which pushes the prices even higher. This results in a continued uptrend and continues till buyers exceed the number of sellers. After there are not enough sellers in the market, the market changes direction and drives the currency pair prices lower, signalling traders to short the trades. On the other hand, when the prices are trading at a low level, it attracts more and more traders to exit the trade or open short positions, which drives the currency pair prices even lower. This results in a continued downtrend and continues till sellers exceed the number of buyers. After there are not enough buyers in the market, the market changes direction and dives the currency pair prices higher, signalling traders to long the trades.
- Traders open new long or short positions when the trend strength is strong.
- Traders close the long or short positions when the trend strength is weak.
How to calculate momentum indicators
Momentum indicators in forex compare the currency price of a currency pair with the price of the previous periods (N) that the trader is considering. First, the trader chooses the timeframe they want to consider in which they want to compare the currency pair prices. The default value of the period N is 14 in automated trading systems like MT4 and MT5. Traders can change this value for a higher or lower number. Momentum indicator formula = (current closing price/closing price of the currency pair n periods ago) * 100
What are the top momentum indicators?
Relative Strength Index (RSI)
Relative Strength Index or RSI is one of the most popularly used momentum indicators that provide both buy and sell signals in trending markets. It is plotted below the price chart and provides values ranging from 0 to 100. It also provides overbought and oversold market signals that help traders with reversing market trends based on which they can long or short the trade.
- Values above 70 indicate an overbought market and signal traders to enter short positions due to an expected downtrend.
- Values below 30 indicate an oversold market and signal traders to enter long positions due to an expected uptrend.
The momentum oscillator identifies the strength of a trend by comparing the current and previous closing prices of a currency pair. It is drawn as a single line on the price chart that moves below and above a centreline. It provides values to traders between -100 to 100 that help in analysing how quickly or slowly the currency pair prices are moving.
- Values in the -100 range between -100 to 0 signal a negative momentum in the market with decreasing prices and signal trades to enter short positions.
- Values in the +100 range between 0 to 100 signal a positive momentum in the market with increasing prices and signal traders to enter long positions.
Moving Averages can identify emerging trends by filtering out random price fluctuations. It shows the prevailing price trend based on which traders can long or short a trade. This indicator tells traders if the market is trading in a range or not. A trader can apply two or more moving averages on the price chart (both long-term and short-term) to understand if the trend is accelerating or not. The crossovers provide traders with a signal as to which trade to open in the market.
- When the short-term moving average crosses the long-term moving average from above, it indicates an uptrend momentum and signals traders to place buy or long order.
- When the short-term moving average crosses the long-term moving average from below, it indicates a downtrend momentum and signals traders to place short or sell orders.
Top Momentum indicator signals you should know
Momentum indicator provides traders with divergence signals in the forex market. A bullish divergence signal occurs when the currency pair prices make lower lows, but the momentum indicator makes higher lows. This signals traders to place long orders to profit from the expected uptrend. However, a bearish divergence signal occurs when the currency pair prices make higher highs, but the momentum indicator makes lower highs. This signals traders to place short orders to profit from the expected downtrend.
100-line cross signals
The 100-line cross signal indicates where the prices are moving in the market. When the currency pair prices cross the 100-line form below, it indicates that the currency pair prices are trending upwards, and trades can place buy orders to profit from the bullish market behaviour. On the other hand, when the currency pair prices cross the 100-line form above, it indicates that currency pair prices are trending downwards, and traders can open short orders to profit from the bearish market momentum.
Traders can add the simple moving average (MA) line of the momentum indicator to the price chart to receive crossover signals. The common time period for the moving average is 10, 14 or 21 periods. Plot the momentum line and the moving average line to receive the crossover signal. Whenever the momentum line crosses the MA line from below, it signals traders to enter buy orders due to an expected uptrend. Whereas, when the momentum line crosses the MA line from above, it signals traders to enter short or sell orders due to an expected downtrend.
Factors affecting the momentum indicator signals
Volume refers to how much of the particular currency pair is traded in a specific time period. It is an important factor affecting momentum indicators as they help identify quick entry and exit positions. The entry and exit orders rely on a stable number of buyers and sellers trading the currency pairs. The more liquid a market is (due to high volume), the easier it is to trade the currency pair after analysing the market momentum. When the market has low volume, it becomes tough for the momentum indicators to identify the right market momentum.
2. Time frame
Momentum indicators provide trading signals mostly in the short-term timeframe. The longer the trade is able to maintain its strength in the market in the short-term time frame, the easier it is for momentum indicators to provide traders with the right trading signals. If a trade is not able to maintain its strength in the short term, momentum indicators can provide false signals or no signals to enter or exit the trade.
Volatility is one of the most important things that helps momentum indicators provide ideal signals. It refers to the degree of change in a currency pair’s price movement. When a market is highly volatile, it witnesses big price swings, and less volatile markets witness low price swings. Momentum indicators take the help of short-term price increase and decrease to capitalise on market volatility and provide ideal entry and exit orders in adverse market situations.
Understanding the momentum indicator trading strategy
The momentum indicator trading strategy in a forex market works with a 100 line, also called the centre line. This line helps identify buy or sell signals in the market as per the price momentum. Whenever the momentum indicator crosses the 100-line from above, it sends traders a signal to buy the trade, and whenever it crosses the 100-line from below, it signals traders to sell the trade. Whenever the momentum indicator crosses the 100-line, it means that the currency pair prices are rising in an uptrend or falling in a downtrend. However, when the momentum indicator crosses the 100-line from above (or below) but immediately falls below (or rises above) it, it signals that the market is likely to reverse, and the traders should either hold the trade or open a position opposite to the current direction.
Entry, Limits and Stops Strategy With Momentum Indicators
With momentum indicators, traders can use different indicators like MACD and Bollinger Bands to identify the ideal entry levels. Take a market long or short order when a buy or sell signal comes, respectively. The entry signal is provided either at the downtrend’s highest or the uptrend's lowest price level. Currency pair prices continue to trade in the same direction for some time before they retrace. This is the second ideal entry opportunity for traders before the market starts moving against them. Stops and limits order can be placed by combining the momentum indicators with Bollinger bands. Different traders can place stops and limits based on their risk and reward ratio criteria, but most of them place the stop orders at one standard deviation away from opposite to the Bollinger Bands entry level. This helps traders profit from medium-level price movements in extreme market situations.
How to trade with momentum indicators
- Identify the currency pairs that you want to trade within the current trending market.
- Use a momentum indicator like RSI or moving averages to understand where the current trend is headed.
- If the current trend is going to continue trending in the same direction, open a trade in the trend’s direction. Otherwise, open a trade in the opposite direction of the trend.
- Monitor your opened trades in the forex market and look for a reversal signal once the trend has continued for a while.
- Before the market reverses, exit from the current trades.
Start trading with momentum indicators
With momentum indicators, you can successfully enter short orders during a bearish market and long orders during a bullish market. Start trading with Blueberry Markets, a global trading platform and combine different technical indicators to receive confirmed market signals. Sign up for a live trading account or try a risk-free demo account.
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