In trading, momentum indicators are used to predict the future movement by looking at its current trend. There are many different types of momentum indicators, broadly categorized into three groups: short-term, intermediate-term, and long-term.
Some are based on simple arithmetic calculations, while others use moving averages in some way to provide investors with more advanced information about potential price movements.
This article explains the types of momentum indicators and how you should use them in conjunction with other aspects of technical analysis to inform your investment decisions. The following are some of the different types of momentum Indicators.
Developed by Larry Williams, a former floor trader, Williams %R is based on a moving average. If a stock is above its 20-day moving average, it is said to have upward momentum and thus bullish Williams %R reading.
If its price is below that moving average, it has downward momentum and a bearish Williams %R reading. The price is overbought or near the high of its previous price range when the indicator is between 20 and zero and is oversold. It may also be far from the high of its recent content when the needle is between 80 and 100.
The idea behind Williams %R is that if you are trading with the trend, you’ll be better served holding stocks with upward momentum rather than those in a downtrend.
It is one of William’s original momentum indicators, and it displays short-term movements in a stock price. The Ultimate Oscillator can be calculated between 0 and 100, with values below 30 indicating an oversold position and above 70 indicating an overbought situation. Trading signals are generated using a three-step approach when the price moves in the opposite direction of the indicator.
Directional Movement Index (DMI)
The Directional Movement Index (DMI) is an oscillator that indicates the direction in which the price of an item is moving using a directional movement line(Dl) on a scale from -Dl to +Dl.
When +DI exceeds -DI, the price is under more significant upward pressure than downward pressure. If the -DI is higher than the +DI, the price is downward.
Relative Strength Index (RSI)
This is a prevalent momentum indicator developed by J. Welles Wilder Jr. and published in his book New Concepts in Technical Trading Systems. The RSI measures overbought and oversold conditions by comparing a security’s price movement overtime to its historical average.
When RSI falls below 30, it suggests that a stock may be oversold and could bounce back; when RSI rises above 70, it indicates that a stock may be overbought and due for some profit-taking.
Chaikin Money Flow (CMF)
Marc Chaikin’s Chaikin Money Flow (CMF) is a volume-weighted average of accumulation and distribution over a given period, typically used for 21 days.
Its concept states that the closer the closing price is to the high, the more accumulation has occurred, and the closer the closing price is to the low, the more distribution has occurred.
A CMF value above the zero line indicates market strength, while a value below the zero line indicates market weakness.
Accumulation/Distribution Line (A/D)
This is a technical indicator that measures buying pressure compared to selling pressure. The A/D line tracks volume over time and plots it separately.
It compares cumulative buying volume with cumulative selling volume. When buyers outpace sellers, prices rise, and when sellers outpace buyers, prices fall.
Developed by John Bollinger, they are a technical analysis indicator that uses volatility to measure price levels. Bollinger Bands consist of three lines based on standard deviation: a moving average upper and lower bands.
The upper band is two standard deviations above an average, whereas the lower band is two standard deviations below an average.
On Balance Volume (OBV)
The OBV indicator, developed by Joseph Granville, is calculated using two different calculations: Open Interest and Accumulation/Distribution. If more money enters a stock than exits a stock on a given day, that day’s OBV reading will be positive.
If more money exits than enters, that day’s OBV reading will be negative. Over time, as markets trend upwards or downwards, there will be more volume exiting positions and entering positions.
Force Index (FI)
The force index is a momentum indicator developed by Larry Williams. The force index measures the strength of a price move by combining price and volume.
It is an oscillator that swings back and forth between positive and negative areas and is unlimited, which means it can go up or down indefinitely.
The force index is used to validate trends and breakouts and identify possible turning moments by recognizing divergences. Williams says that stocks with a positive Force Index tend to go up and stocks with a negative Force Index tend to go down.
Chaikin A/D Oscillator (CDO)
Developed by Marc Chaikin, CDO is one of the more basic momentum indicators. It compares a
10-period and a 3-period moving average determine whether an asset is overbought or oversold.
An asset is considered overbought when the 10-period moving average rises above the 3-period moving average; similarly, it will be considered oversold when the 10-period moving average falls below its 3-period moving average.
There are several momentum indicators available to traders. Similarly, each trader has their preference and use, but it is wise to understand what they are and how they work, even if they choose not to trade them actively.