The Momentum Oscillator is a technical indicator that measures the change of price of a financial instrument over a given time span. In other words, it is a speed of movement indicator designed to identify the speed (or strength) of price movement. The momentum indicator compares the most recent closing price to a previous closing price (can be the closing price of any time frame).
• Calculation
There are several variations of the momentum indicator, but whichever version is used, the momentum (M) is a comparison between closing price (CP) and the closing price “n” periods ago (CPn), which is determined by users. The default setting of momentum is “14” in the daily chart, meaning that the indicator is comparing the current price to the price 14 days ago.
M = CP – CPn
Or
M = (CP/CPn) * 100
The first calculation is taking the difference between the two closing prices and plotting it. While the second version of the indicator shows the price difference between the current price and the price “n” periods ago as a percentage.
• Interpretation
The Momentum Oscillator identifies when the price is moving upwards or downwards, and by how much. When the momentum indicator is above 100 or 0, the price is above the price “n” periods ago, and when the momentum indicator is below 100 the price is below the price “n” periods ago.
Actually how far the indicator above or below 100 or 0 indicates how fast the price is moving upward or downward. For example, a reading of 101 shows the price is moving quicker to the upside than a reading of 100.5, and a reading of 98 shows the price is moving with more force to the downside than a reading of 99.
• Application
1) 100 Line Cross
The 100 line is depicted to be a benchmark at the indicator window (if the indicator is based on the second calculation). When the price crosses above or below the 100 line, it likely represents a buy or sell signal respectively.
For example, if the price crosses above the 100 line it shows the price is starting moving upward, as the price has moved above the price “n” periods ago. It is shown as follows:
On the other hand, a drop below the 100 line indicates the price likely begins declining since it has moved below the price “n” periods ago. It is shown as follows:
2) Divergence
Bullish Divergence
If the price is moving lower, while the lows on the momentum indicator are moving higher, like what it is shown in the Figure 3, this is a “bullish divergence”. It is meaning that while the price is dropping, the momentum behind the selling is slowing, helping investors confirm a buy signal.
Bearish Divergence
If the price is moving higher, but the highs on the momentum indicator are moving lower, as what it is shown in the Figure 4, this is a “bearish divergence”. It is meaning that while the price is rising, the momentum behind the buying is declining, helping investors seek a sell signal.
However, divergence should never be used on its own since it is not reliable. It is more accurate to be used to confirm trade signals companied with other strategies.
• Conclusion
Despite the momentum indicator can give some information about trading signals by “100 Line” and “Divergence”, it should be used with other indicators to increase its accuracy. Actually, it can be more useful for spotting subtle shifts in the force of buying and selling rather than aggressive changes in prices, mainly through the use of divergence.