On the charts in this column everyday is the Momentum indicator. Some call
it the Rate of Change indicator.
Definition:
The Momentum indicator or Rate of Change indicator is a popular study
available in most analytical charting programs.
The use of the indicator can vary from trader to trader. Most use it as a
trend following indicator; while others use it as an oscillator to help
pinpoint possible overbought and over sold conditions.
The indicator measures the rate of change in price as opposed to price
itself. It is calculated by subtracting the price of x periods ago from the
price now. This indicator can also be referred to as rate-of-change (ROC).
As with most indicators and studies, it can be used on various time frames.
The same calculation is used for 5 minute, 15 minute, 60 minute or daily
price bars. We use it here with 60-minute bars.
To reduce the choppiness of the indicator, I prefer a longer period. I then
apply a Moving average of the indicator to further smooth this very
volatile indicator when using with short time periods. The chart below
reflects the smoothed 5 period exponential moving average derived from a 22
period Momentum indicator on 60-minute bars.
Interpretation:
The conventional interpretation is to use momentum as a trend-following
indicator. This means that when the indicator peaks and begins to descend,
it can be considered a sell signal. The opposite conditions can be
interpreted when the indicator bottoms out and begins to rise.
If momentum reaches very high or low values relative to its range
historically, a continuation of the current trend is likely, and a change
might not be considered until the actual price begins to dip down or rise,
respectively.
As with all technical indicators, it is often useful to verify the signals
you are interpreting with other indicators
Let's look at Microsoft Corporation (NASDAQ: MSFT)
From the chart below, you can see how MSFT stock moves in relationship to
the Momentum indicator.
Each time Momentum indicator changes at a plus reading, the stock runs out
of Momentum and turns down.
Each time the downward Momentum stops and the indicator turns up, the stock
rallies.
I like to combine the Momentum indicator with some of my other favorite
indicators like MACD and Moving Average Crossovers.
You can see from the chart below that these indicators are also gave a Buy
signal today.
I would Buy MSFT on any positive movement in the morning.
I would place my stop at 91.
