Momentum
On the charts in this column everyday is the Momentum indicator. Some call
it the Rate of Change indicator.
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
There are many stocks and sectors that look just like the following example.
Let's look at International Business Machines (NYSE: IBM)
The momentum indicator for IBM has been negative for the past few weeks.
There was a rally attempt in the October 5, and 6 time frame that failed.
Once again, we are now seeing the Momentum indicator turn up.
This change from down to up Momentum is occurring because the rate of
change of the decline is slowing.
What is needed is for prices to confirm the indicator. You can see from the
chart below that price consolidation is taking place now in IBM.
If price can break above 109 �, this would confirm the Momentum
indicator and a possible rally can take place from this base that has
formed over the past few days.
The proper way to play these breakouts is to wait for confirmation by using
entry orders above the current market.
I would Buy IBM on a Buy stop at 109 �.
If filled, I would place my stop at 107.
If IBM does not move to 109 �, DO NOT take the trade.
