Anyone familiar with technical analysis knows that momentum values can be used for all kinds of trading strategies. Where traders depend on the strength of recent price action to decide whether to buy or sell an asset. But how credible is momentum in determining a profitable trade? We are about to find out.
As you know, momentum is the rate of change in the price of an asset. The direction of momentum can be calculated by taking the price differences for a fixed period of time, it may be over months, weeks, days, or even minutes. The momentum value is often plotted against a zero line. If the current price is higher than the previous price then it’s positive momentum. And it’s called negative momentum if the current price is lower than the previous one.
Traders commonly use technical indicators to determine the rate of price change of an asset. The most popularly used momentum indicators are the Moving Average Indicator and Relative Strength Index. The RSI measures the strength and speed of price action by comparing its up and down movement over a period of time. This momentum indicator oscillates between zero and hundred.
A moving average indicator averages the price of a currency pair over a period of time. It is called a moving average because as new data gets added the line on the chart moves forward. This indicator is popular for its simplicity as it helps traders smooth the price data to easily determine whether the price is moving upward, downward, or sideways.
Momentum trading strategy is based on the concept that if an asset price moves strongly in one direction, it will continue to do so for some time. A momentum value above zero indicates that the price is going up and a value below zero means the price is going down.
Momentum trading can be mainly divided into two categories: relative momentum and absolute momentum. When the price of different trading instruments within an asset class is compared against one another it is called relative momentum strategy. Whereas, when a single instrument’s price is compared to its previous price performance, it’s called absolute momentum strategy. While employing a momentum trading strategy in forex, both absolute and relative momentum can be utilized.
Since momentum is an unbound oscillator there is no upper or lower boundary. This makes it harder to interpret whether if a currency is overbought or oversold. But basically, positive momentum in an uptrend means it’s time to buy and a negative momentum in a downtrend means it’s better to sell. However, you can’t completely rely on a momentum value to place a trade, mixing it up with other indicators will give you a more reliable conclusion.
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