How to Use Momentum Indicator in Forex Trading

How to Use Momentum Indicator in Forex Trading

Forex Trading can be a wild ride, with dramatic ups and downs that would make a rollercoaster jealous. But fear not, because we have the trusty Momentum Indicator by our side. Think of it as your personal hype man, hyping you up every time the market starts moving in your favor. It’s like having a tiny cheerleader in your chart, shouting “You got this! Keep going!” So put on your trading shoes and get ready to ride the wave of market momentum with the one and only Momentum Indicator!” 

Keeping up with the momentum in the Forex market is essential for successful trade execution & staying ahead of market fluctuations. By identifying momentum, traders can make more informed decisions about entering and exiting trades, potentially leading to better risk management and higher profits. The Momentum Indicator is one tool that can be used to measure momentum. The purpose of this article is to provide you with all the insights into the Forex Momentum Indicator, how to incorporate it into your trading strategy, and much more!

What is the Momentum Indicator? 

The Momentum Indicator is a widely used technical analysis tool in Forex Trading. It is designed to measure the speed and magnitude of price changes in a currency pair. The indicator is calculated by subtracting the currency’s closing price from a certain number of periods ago from its current closing price. The resulting value can then be plotted as a line on a chart and used to determine the strength of the currency’s trend. 

Forex Trading with Momentum Indicator
The Momentum Indicator belongs to the Oscillator class of technical trading indicators. Depending on the indicator settings, the indicator oscillates between values above and below a central line, usually set at 100. As a leading indicator, the Momentum Indicator can also provide early signs of potential trend changes in the Forex market. 

The Momentum Indicator is typically used to determine the strength of a currency’s trend. A positive momentum reading indicates that the currency is gaining strength and may continue to rise, while a negative momentum reading suggests that the currency is losing strength and may decline. 

The Momentum Indicator can also be used to identify potential trend reversals in the trend analysis. A sudden change in the Momentum Indicator’s direction can signal a potential trend reversal and traders may look to close existing positions or enter opposite positions. 

Forex traders often use the Momentum Indicator in conjunction with other technical analysis tools to make informed trading decisions. Three of the most well-known and widely used momentum indicators are the Relative Strength Index (RSI), the Moving Average Convergence Divergence (MACD), and the Momentum Indicator found in the Meta Trader platform. 

For example, if the Momentum Indicator shows a positive reading and the currency is above its moving average, the trend is considered to be bullish, and traders may look to enter a long position. Conversely, if the Momentum Indicator shows a negative reading and the currency is below its moving average, the trend is considered bearish, and traders may look to enter a short position. 

Understanding and Trading with the Momentum Indicator 

The Momentum Indicator determines whether the price is moving upwards or downwards and, if so, how strongly it is moving. Instead of measuring the actual price change itself, momentum measures how fast prices change. The process by which momentum is measured is by continually taking price differences for a fixed period of time and evaluating them. 

Basically, what it does is compare where the price is at the moment with where it was in the past, and then plots the result around a zero line.  

  • Momentum is positive if the current price is higher than the past price. 
  • Momentum is negative if the current price is lower than the past price. 
Since the Momentum indicator does not have predefined upper and lower limits, you need to examine its historical data and manually draw horizontal lines at its highest and lowest points. 

Here’s how to read the momentum indicator in detail: 

  1. Identify the trend: A positive momentum value indicates an upward price movement, while a negative momentum value indicates a downward price movement. 
  1. Look for divergences: Divergences between the momentum indicator and price action can indicate potential trend reversals. For example, if the price of an asset is making new highs, but the momentum indicator is failing to reach new highs, it may be a sign of a potential trend reversal. 
  1. Overbought/Oversold conditions: When the momentum indicator reaches high positive values, it is considered overbought, and when it reaches low negative values, it is considered oversold. These conditions can indicate potential market reversals. 
  1. Crossovers: Crossovers of the momentum line with its centerline or with a signal line can also indicate potential trend reversals or trade signals. 

It’s important to note that the momentum indicator should be used in conjunction with other technical indicators and analysis tools to confirm signals and make informed trading decisions.

How is the Momentum Indicator Calculated? 

A Momentum Indicator formula has a few versions, but whichever one is used, the momentum (M) is based on a comparison between the current closing price (CP) and a closing price “n” period ago (CPn). The “n” is a user-defined time period, usually 14 periods, but it can vary depending on the analysis.  

The Momentum Indicator Formula: 

Version 1: M = CP – CPn 

Version 2: M = (CP / CPn) * 100 

In the first version, the difference between the two closing prices is taken into account. Based on the second version, momentum is defined as the percentage change in price over time. The resulting value is then plotted as a line on a chart and can range from positive to negative values.  

The Momentum indicator does not offer much insight that can't be seen by just examining the price chart. A sharp increase in price will be evident on both the price chart and the Momentum indicator. While the Momentum indicator can be used to generate trading signals, it is most useful in confirming the validity of trades determined by price movements such as breakouts or pullbacks. 

How to Use the Momentum Indicator on Meta Trader

Forex traders can access the Momentum Indicator for free, as part of the standard suite of indicators provided by the Meta Trader platform. The Momentum Indicator can be easily configured in MetaTrader 4 (MT4) as follows: 

  1. Open the MT4 platform and go to the “Navigator” window, which is located on the left side of the platform. 
  1. Right-click on “Indicators” and select “Custom Indicators.” 
  1. Scroll down the list of indicators until you find “Momentum” and double-click on it or drag it onto the chart. 
  1. A “Momentum Indicator” window will appear. You can adjust the settings as desired, such as the period (default is 14), the color, and the line style. 
  1. Click “OK” to apply the changes and the Momentum Indicator will appear on the chart. 

As you become more familiar with the Momentum Indicator, you can experiment with its settings to discover what works best for you. The best way to get started is with a Forex Cent Account

Trading Signals generated by Momentum Indicator 

Momentum indicator signals are signals generated by technical analysis tools that are designed to measure the strength and direction of a trend in the market. These signals are used to help traders make decisions about buying or selling securities. The following section discusses the three most popular types of signals derived from the Momentum Indicator. 

1. 100 Line Cross – Analyze Trend Direction & Strength 

The 100 Line Cross is a signal generated by the Momentum Indicator, which is used to assess the direction and strength of a trend in the market. When the price of an asset moves from below the 100 Line and crosses it upwards, it signals that prices are rising, and traders may consider taking a bullish position. Conversely, when the price moves from above the 100 Line and crosses it downwards, it signals that prices are decreasing, and traders may consider taking a bearish position. 

It is crucial to keep in mind that relying solely on the 100 Line Cross can result in false signals and is not recommended. Instead, traders should keep an eye on the position of the price relative to the 100 Line and use additional filters to determine the best entry points. For instance, during an upward trend, traders may wait for prices to retreat below or to the 100 Line before crossing back above it and use a 3-bar breakout as a further filter for entering the trade. 

In conclusion, while the 100 Line Cross is one type of signal provided by the Momentum Indicator, it should not be used in isolation, and traders should always incorporate other forms of analysis and market data when making trading decisions. 

Check out the chart below to see how this works: 

How to Use Momentum Indicator in Forex Trading

2. Crossover Signal – Indicate Trend Formation 

The Crossover Signal is another type of signal provided by the Momentum Indicator. It is generated when two lines, typically a fast-moving average and a slow-moving average, intersect or “crossover”.  

A bullish crossover occurs when the fast-moving average crosses above the slow-moving average, signaling an upward trend in prices and an opportunity for traders to take a long position. Conversely, a bearish crossover occurs when the fast-moving average crosses below the slow-moving average, signaling a downward trend in prices and an opportunity for traders to take a short position. 

The core strategy involves ‘Buying’ when the momentum line intersects the moving average from below and ‘Selling’ when the momentum line intersects the moving average from above. This simple approach can be improved by restricting trades to the direction of the overall trend or waiting until an overbought or oversold condition is present. 

Here is a chart showing a Momentum Crossover Buy Signal and an RSI reading that is oversold. 

How to Use Momentum Indicator in Forex Trading

3. Momentum Divergence Signals – Suggests Trade Opportunities  

Momentum Divergence is a powerful tool in technical analysis. It occurs when there’s a difference between the price action of an asset and the readings of a Momentum indicator or oscillator. A bullish divergence happens when the asset’s price is making lower lows, but the Momentum indicator is making higher lows.  

On the other hand, a bearish divergence takes place when the asset’s price is making higher highs, but the Momentum indicator is making lower highs. This divergence can indicate to traders that the momentum is weakening and could lead to a price retracement or even a trend reversal. It often occurs at market extremes where prices have moved too far, and like a rubber band, they need to return to a value area.  

Divergences are more effective in range-bound markets, but in strongly trending markets, they may provide many false signals. It’s crucial to not use divergences in isolation and to understand what’s happening in the larger time frame. By looking for key support and resistance areas and using them as a backdrop for a divergence setup, the chances of a successful trade can be significantly increased. During a trending market, traders can also look for pullbacks where the price action is diverging from the Momentum indicator.  

A divergence trade setup aligned with the overall trend is likely to be more successful than trying to pick a top or bottom against a strong trend. When attempting a counter-trend trade with momentum divergence, it’s important to have additional evidence that a trend reversal is probable. Despite how far a market has extended or how good a counter-trend divergence signal may look; it could still be a false signal and the market could continue to trend. It’s important to keep in mind the saying, “The markets can remain irrational for longer than you can remain solvent.” 

Let’s examine some examples of divergence. The first example occurs in a range-bound market.

How to Use Momentum Indicator in Forex Trading

Observe the far right of the chart, the price action creates a higher high, while the Momentum Oscillator creates a lower high. This is a strong divergence setup within a range-bound market. Next, let’s look at divergences that occurred during a strong price decline. 

How to Use Momentum Indicator in Forex Trading

In the chart above, you can see that the price is in a strong downtrend. There are three Momentum divergence signals shown on the chart. All three turned out to be false signals, as the price continued to trend downwards. This should make you cautious about trading divergences during strong trends. 

Trading strategies Using Momentum Indicator 

Having gained a strong understanding of the Momentum indicator, its construction, and the signals it provides, we will now move on to exploring various trading strategies that can be utilized when using the Momentum indicator for trading purposes. 

1. Momentum Divergence with Zig Zag Pattern 

Momentum divergence combined with a zig-zag pattern can be a useful trading strategy when using the Momentum indicator. The concept behind this strategy is to identify divergences between the price and momentum indicators, which can signal a potential trend reversal. The zig-zag pattern is then used to filter out small price movements and focus on the larger trend. 

Here’s how it works: 

  • The Zig Zag Pattern is a straightforward pattern based on the Elliott Wave theory and includes three waves: A, B, and C. Wave A start the pattern, followed by the retracement wave B, which must not exceed 100% of Wave A. Finally, Wave C moves in the same direction as Wave A and must surpass it.  
  • To employ this pattern, one should first identify a clear trend in the market. Next, observe a Zig Zag correction within the trend. Finally, look for a divergence formation within the Zig Zag pattern to confirm the trade. 
  • The trade setup will be confirmed once we observe a divergence between the Momentum indicator and price. Our entry signal will occur when the trend line, connecting the start of Wave A to the start of Wave C, is broken. This trend line is referred to as the A-C trend line. 
  • In terms of trade management, the stop loss should be placed beyond the most recent swing point prior to the A-C trend line breakout. The target for taking profits will be set at a level near the start of Wave A. 

Here is an example of Momentum Divergence with Zig Zag in action: 

How to Use Momentum Indicator in Forex Trading

 As seen in the chart, the market shows a persistent downward trend. However, a zig-zag pattern is formed, accompanied by a bullish divergence indicated by the grey dashed line, which points to a potential trend reversal. Hence, traders should prepare for a long trade. 

To initiate the trade, wait for the price to break and close above the A-C trend line. This serves as the entry signal and at this point, traders can open a long trade. The stop loss should be placed below the previous swing low. Finally, exit the trade when the price reaches the starting point of the zig-zag pattern. 

2. Momentum Divergence with Support and Resistance 

The concept behind this strategy is to identify divergences between the price and momentum indicator, which can signal a potential trend reversal, and use support and resistance levels to confirm the trade. The key is to use Support and Resistance levels from a higher time frame to get a better understanding of the overall market condition. 

Steps to follow: 

  1. Identify higher time frame levels: Determine the key Support and Resistance levels from a higher time frame chart, for example, if you’re trading on a 60-minute chart, the levels would be from the 240-minute chart. 
  1. Wait for the price to approach: Wait for the price to move closer to the key Support or Resistance levels on the chart. 
  1. Look for a divergence: Look for a divergence pattern that occurs near the Support or Resistance level. 
  1. Confirm with a crossover: Once the divergence confirms the signal, enter the trade when there’s a Momentum indicator crossover. 
  1. Set a stop loss: Place a stop loss at the most recent swing prior to the Momentum indicator crossover signal. 
  1. Exit the trade: Exit the trade when there’s another Momentum indicator crossover in the opposite direction. 

Here is an example of a Momentum Indicator strategy in action.

How to Use Momentum Indicator in Forex Trading

It’s important to remember that Support and Resistance levels are usually perceived as areas, not single lines or levels, and to use this strategy in conjunction with other technical analysis tools and market knowledge for informed trading decisions. 

Best Indicator Combinations for Momentum Indicator 

When using the Momentum indicator, it’s common to combine it with other technical indicators to generate more reliable signals. Some popular combinations include: 

  1. Momentum and Moving Average: By combining the Momentum indicator with a Moving Average, you can see the trend direction more clearly and confirm the momentum signals. 
  1. Momentum and RSI: The Relative Strength Index (RSI) can provide additional information on overbought and oversold levels, while the Momentum indicator confirms the strength of the trend. 
  1. Momentum and Bollinger Bands: Bollinger Bands are a volatility indicator that can help identify the trend and price action, while the Momentum indicator provides information on the momentum. To learn Bollinger Bands and how to use it is important to have efficient analysis.
  1. Momentum and MACD: The Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that can provide additional information on the trend direction and strength, while the Momentum indicator confirms the momentum. 

There is no one indicator combination that works best for every market condition, and each trader should pick the combination that suits their own trading style and analysis of the market. 

Is Momentum Trading Strategy Worth It? 

The Momentum trading strategy can be a worthwhile approach for traders who are looking to capitalize on trending markets. The Momentum indicator provides clear signals on trend direction and strength, making it an effective tool for determining entry and exit points. When used in conjunction with other technical indicators, the Momentum indicator can help traders generate more reliable trading signals. 

Getting a proper education before trading in the forex market is crucial because it provides a solid foundation of knowledge and understanding about the market and its workings. Forex trading is a complex and dynamic market that requires a deep understanding of various economic and financial concepts, such as market trends, risk management, and technical analysis. 

Look no further, as AximTrade’s comprehensive learn forex for beginners is here to guide you every step of the way!

Forex Trading with Momentum Indicator: FAQ 

How do you use the momentum indicator in forex?

The Momentum indicator can be used in forex to identify the trend direction and strength. It is typically applied to a chart of a currency pair and measures the rate of change of price over a specified time period. Traders can use the Momentum indicator to identify potential overbought or oversold conditions and generate buy or sell signals based on crossovers with the 100 level.

What is the best momentum indicator for forex?

There is no one-size-fits-all answer to this question as the best momentum indicator for forex will depend on the individual trader’s preferences and trading style. However, the most commonly used momentum indicators include the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and the Stochastic Oscillator. 

How do you use the momentum indicator in MT4?

To use the Momentum indicator in MT4, you will need to: 
Open the MT4 platform and select the currency pair you want to analyze. 
Navigate to the “Insert” tab in the toolbar and select “Indicators.” 
From the list of indicators, select the “Momentum” indicator and add it to your charts. 
You can adjust the parameters of the indicator, such as the time period and moving average type, by right-clicking on the chart and selecting “Indicator list.” 

What is momentum strategy in forex?

The momentum strategy in forex is a technical trading approach that involves using the Momentum indicator to identify trend direction and strength. Traders using the momentum strategy aim to enter trades in the direction of the trend and exit when the momentum weakens or changes direction. This strategy can be used in combination with other technical indicators and price analysis techniques to improve the accuracy of trade signals.

Drawbacks of using the Momentum Indicator for forex trading?

One drawback of using the Momentum Indicator for forex trading is that it can produce false signals in choppy or ranging markets. It can also lag behind price movements, which can result in missed opportunities. It’s advisable to implement your strategy in a demo account before making it live.

free online forex course