The momentum indicator at core of the oscillator family, and understanding how to interpret this indicator will help you to better understand all the other oscillators. Momentum measures the rate of change rather than price itself.
A fundamental principle in using momentum as an indicator is to buy when momentum crosses zero (or 50 in the case of RSI) to the upside, or to sell when it crosses below zero to the downside. Another basic principle of interpreting momentum is divergence – this occurs when price is rising or falling and momentum starts to flatten or move in the opposite direction.
What is momentum?
– Momentum measures the velocity of price changes – the acceleration rate of ascent or descent of price. Momentum is a leading indicator in that it turns before price itself does.
– 10 day momentum is a commonly used time period, however any time period can be used. The longer the time period used the smoother the line appears.
– Momentum is measured using price changes over a fixed time period.
– In the case of a 10 day momentum line, if the latest closing price is greater than it was 10 days ago, a positive value is plotted above the zero line. If the latest closing price is below that of 10 days ago a negative value is plotted below the zero line
– When prices are rising and the momentum line is above the zero line and rising this shows that the uptrend is gaining momentum.
– When the upward pointing line begins to flatten out this shows that the new gains are equal to the advances made 10 days earlier. Prices are still rising – but the rate of acceleration is no longer rising.
– When the momentum line begins to drop towards the zero line, the price is still going higher, but the rate is decelerating.
– When the momentum line goes below the zero line, the latest closing price is below that of the prior period and prices are moving lower.
– Momentum crossing the above zero line in the direction of the trend is a buy signal, crossing below is a sell signal.