BENEFITS OF MOMENTUM IN TRADING
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The Momentum Indicator is a speed of movement indicator to identify the speed of price movement. The momentum indicator compares recent closing price to a previous closing price.
The interpretation of the Momentum indicator is identical to the interpretation of the Price ROC. Both indicators display the rate-of-change of a security's price. However, the Price ROC indicator displays the rate-of-change as a percentage whereas the Momentum indicator displays the rate-of-change as a ratio.
The calculation of Momentum is quite simple (n is the number of periods the technical trader selects):
The current price minus the price n-periods ago
Hence, if the current price is higher than the price in the past, then the Momentum indicator is positive. In contrast, when the current price is lower than the price in the past, then the Momentum indicator is negative.
a) Momentum indicator crosses above the zero line, the crossing of the zero line implies that the price of the stock, future, or currency pair is reversing course, either by having bottomed out or by breaking out above recent highs; this is typically viewed as a bullish signal.
b) Momentum indicator crosses below the zero line. A cross of the zero line can generally mean two things: the future, currency pair, or stock's price has topped out and is reversing or that the price has broken below recent lows, either way, these events are often interpreted by traders as bearish signals.
Final Word on Momentum Indicator
The momentum indicator isn't going to give a trader much information over and above what can be seen just by looking at the price chart itself. If the price is moving aggressively higher, this will be visible on the price chart and on the momentum indicator. The momentum indicator can be useful for spotting subtle shifts in the force of buying or selling though, mainly through the use of divergence .The momentum indicator is best used in conjunction with price action strategy, providing confirmation as opposed to using the indicator to generate trade signals on its own.
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