The Momentum indicator measures the amount that a
security's price has changed over a given time span.
Interpretation
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.
There are basically two ways to use the Momentum
indicator:
You can use the Momentum indicator as a
trend-following oscillator similar to the MACD (this is the method I
prefer). Buy when the indicator bottoms and turns up and sell when the
indicator peaks and turns down. You may want to plot a short-term
(e.g., 9-period) moving average of the indicator to determine when it
is bottoming or peaking.
If the Momentum indicator reaches extremely high or low values
(relative to its historical values), you should assume a continuation
of the current trend. For example, if the Momentum indicator reaches
extremely high values and then turns down, you should assume prices
will probably go still higher. In either case, only trade after prices
confirm the signal generated by the indicator (e.g., if prices peak
and turn down, wait for prices to begin to fall before selling).
You can also use the Momentum indicator as a
leading indicator. This method assumes that market tops are typically
identified by a rapid price increase (when everyone expects prices to
go higher) and that market bottoms typically end with rapid price
declines (when everyone wants to get out). This is often the case, but
it is also a broad generalization.
As a market peaks, the Momentum indicator will climb sharply and then
fall off-- diverging from the continued upward or sideways movement of
the price. Similarly, at a market bottom, Momentum will drop sharply
and then begin to climb well ahead of prices. Both of these situations
result in divergences between the indicator and prices.
Example
The following chart shows Integrated Circuits and
its 12-day Momentum indicator.
Divergences at points "A" and "B" provided leading
indications of the reversals that followed.
