Trading Tools 101: Momentum IndicatorsDec 10, 2021
Trading stocks strategically involves numerous tools and tricks of the trade. One of them is momentum indicators. If used correctly, momentum indicators can strengthen your trade signals and help you make better, more strategic choices when it comes to your stocks and how they’re moving. Here’s a quick look at momentum indicators to help you learn how to trade stocks.
What do momentum indicators actually indicate?
A momentum indicator measures the price rate of change (ROC) of a security. By comparing the current price with the price of previous periods, one can make bullish or bearish interpretations of the data. So, no matter which direction the stock is moving, traders can get an idea of the price movement over time and how strong those movements are.
What is the formula?
When it comes to momentum indicators, you want to find the momentum (M) by using the current closing price (CP) and comparing it to a previous closing price for a certain period (CPn). You determine what you want the period to be. There are then two ways to find M: as a number or as a percentage.
To find momentum as a number, you run your numbers through this formula:
M = CP - CPn
Pretty easy! If the number is positive, the momentum is upward; if it’s negative, the momentum is downward. How above or below zero the number indicates the rate at which it’s moving.
For momentum as a percentage, follow this formula instead:
M = [CP/Cpn]*100
Like the above formula, a percentage higher or lower than 100 indicates the direction, and how far it is above or below 100 indicates the rate.
Why is this helpful?
Momentum indicators help identify where the market is likely to reverse. These bullish and bearish interpretations (which we mentioned before) are noted through divergence between momentum and price movement and crossovers. Momentum indicators can provide trade signals — however, they’re best used with a handful of other tools rather than on their own. There are also several kinds of momentum indicators available.
What are the Odds?
While knowing the momentum value helps, what matters more are the Odds for what happens next. Momentum indicators simply provide a signal to tell you what has been occurring up to that point. They reveal the context, by showing the performance of a stock after a certain number of days (remember CPn?), but by themselves they do not inform a Trader of the subsequent behavior after the signal.
Taking Momentum scores and calculating Odds and subsequent average performances that have occurred in the past when stock symbols achieve those same scores, adds an entirely different perspective and provides the trader with the ability to trade with quantifiable probabilities rather than the guesswork that accompanies reading a signal only. In short, one is much more able to place an educated bet.
It is always difficult to tell whether a stock trending up will continue that trend or reverse. This is why viewing these signals from what is most likely to occur because of the number of times it has occurred previously is a massive step in the right direction if one loves using indicators for trading.
You may find some of your best trades come from being contrary to the indicators the way they are typically used. Example; an overbought stock may stay overbought for a long period of time, and the Odds may have indicated to stay Long or keep buying it again, day after day.
What to keep in mind?
Indicators might be best used with other indicators. StockOdds calculates Odds and Average Performances on a variety of Signals or indicator scores. You may find that by combining Momentum, or RSI with Bollinger Bands, you smooth your performance.
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