Getting to Know Momentum
Many investors will confuse a trendline with momentum. However, as an event derived from astute technical analysis, Momentum tells investors a lot more than a cursory glance at a security price’s trend line. Using technical analysis and technical events like Momentum, investors are able to determine whether a price is likely to continue its trend or reverse and head the other way.
What Is Momentum Similar to the Moving Average Convergence-Divergence (MACD) oscillator, Momentum measures how much a security’s price has changed over a given time. With a understanding of technical analysis and this particular event, investors will understand whether a slight pull back in price is part of the normal fluctuations of stock prices or if it is indeed a bearish signal for the price.
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.
Figuring Out Momentum When it comes to completing your own technical analysis, you may encounter difficulty or frustration with the sometimes complicated mathematical formula. Luckily with Momentum, the calculation is rather simple. To obtain a Momentum reading, you take the closing price of a security, divide it into the closing price from ten periods ago, and multiply it by 100. In other words: 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.
In fact, with most signals derived through technical analysis, investors are advised to use other signals or patterns to confirm or refute a trade opportunity. Momentum is often used to confirm other events or price trends.
Despite Momentum being a fairly simple even to calculate, combining it with a dozen or more other events can become burdensome. Most investors rely on trading software to calculate buying opportunities based on technical analysis. Some trading software will even make simple buy and sell recommendations. While understanding technical analysis is important, completing the work yourself is not.
With more than 16 years of financial services experience, Chris believes that Dividend Funds are instrumental to proper Investment Management Strategies.
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