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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.
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