There is lot more to trading than just price reflected on the charts. Momentum is also an important aspect of trading. One has to incorporate the momentum aspect in making trading decisions because price tells only half the story. The other half is told by the momentum. Inferior trade set ups can be avoided if momentum is also looked into.

Importance of Momentum Indicators

It is very easy to identify the major trend by naked eyes. Minor trends are sometimes present in a major trend. You need to closely follow the chart to identify these minor trends. Momentum indicators help you identify these trends much earlier with greater reliability.

Let me explain the importance of momentum of the price. Say you are watching a car going past you. The driver has reduced the speed of a car. You will not feel its decreased speed because you are not in the car. Unlike you, driver in the car will feel the decrease in speed. Price on the charts will only tell you that car is going somewhere. But the momentum indicators will tell you the speed with which it is travelling.

Better Trading Decisions with Momentum Indicators

Why is it important to know the momentum? As a trader you will typically be in a trade from few minutes to few days. You don\’t want to be in a trade if the strength of the trend is waned. Ideally you should be in a trade when there is a strong momentum going with you. Momentum indicators will help you in determining the momentum of the trend. But a warning before you even think of using momentum indicators. They should never be used alone to make trading decisions. Likewise, price should not be used alone. If price and momentum indicators are used in tandem, you will get better trading results. Commonly used momentum indicators are RSI, Stochastic, CCI and William\’s %R. There are different ways in which momentum indicators are used to produce trading signals.

Divergence between Price and Indicator

The most popular way is to use it for divergence. Divergence occur when the price and momentum move in opposite directions. This is a classic trading signal for a trend reversal. Trend takes few days to reverse. It continues to trend even though the underlying momentum is fading. Price moves up but the momentum indicator shows the downtrend. This implies that the reversal of a trend is round the corner. Then you should look to trade against the trend.

Look for Crossing of Two Signals

Crossover is another favourite play of many traders. Traders look for two signals to cross which gives a trading signal. In case of MACD, a buy trade can be initiated if MACD cuts the signal line from below and goes above it. Similarly if MACD line crosses the signal line from above and goes below it, sell signal is generated.

Overbought and Oversold Conditions

Momentum indicators can also be used with overbought and oversold levels. RSI and Stochastic are the two most important momentum indicators which depict these conditions. Such indicators are used to make better entries and exits.

Momentum indicators help you to determine the continuation as well as the reversal of the trend. It should always be used with other technical analysis tools such as price action, volume etc. A high probability set up is the one which turn in your direction immediately. If you master the techniques to use momentum indicators with price action, it is one of the most effective combination of trading.

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