Momentum
Let’s look at the Momentum indicator used on our charts.
The Momentum indicator or Rate of Change indicator is a popular study
available in most analytical charting programs.
The use of the indicator can vary from trader to trader. Most use it as a
trend following indicator, while others use it as an oscillator to help
pinpoint possible overbought and over sold conditions.
The indicator measures the rate of change in price as opposed to price
itself. It is calculated by subtracting the price of x periods ago from the
price now. This indicator can also be referred to as rate-of-change (ROC).
As with most indicators and studies, it can be used on various time frames.
The same calculation is used for 5 minute, 15 minute, 60 minute or daily
price bars. We use it here with 60-minute bars.
To reduce the choppiness of the indicator, I prefer a longer period. I then
apply a Moving average of the indicator to further smooth this very
volatile indicator when using with short time periods. The chart below
reflects the smoothed 5 period exponential moving average derived from a 22
period Momentum indicator on 60-minute bars.
The conventional interpretation is to use momentum as a trend-following
indicator. This means that when the indicator peaks and begins to descend,
it can be considered a sell signal. The opposite conditions can be
interpreted when the indicator bottoms out and begins to rise. If momentum
reaches very high or low values relative to its range historically, a
continuation of the current trend is likely, and a change might not be
considered until the actual price begins to dip down or rise, respectively.
Many technicians will also use it when it crosses from below the zero line
for Buys and when it crosses from above to below for Sells.
I also like to use it combined with channels and OBV (On Balance Volume)
Let’s look at CMGI, Inc. (NASDAQ: CMGI).
CMGI has a history of being a very volatile stock. Over the past month,
CMGI has been going nowhere. The stock has been range bound between 78 and
92. For a volatile stock like CMGI, this range can set up a very tradable
base for a trade.
These broad ranges can play havoc with trade following techniques as each
move in either direction reverses and causes small losses for the trader.
But breakouts from these large bases can produce an excellent trade into a
new and large trend.
The smoothed Momentum indicator used in these charts can also provide
information into the future direction of the breakout.
Notice the break on September 3 up out of congestion. A few days later on
September 8, CMGI retraced part of the move, but not enough to change the
direction of the Momentum indicator.
On September 9 and 10th, CMGI continued to move up and the Momentum
indicator is now moving up again.
The OBV indicator (On Balance Volume) looks similar in that it did not make
a lower low during the recent retracement.
Risk vs. reward is critical in looking at a trade. I like to use a 3-1 risk
reward ratio. If the trade works out, can I possibly make 3 times my risk.
In this trade, I feel a close stop can be placed at 86 � while the
potential of CMGI breaking out may reward a trader with the start of a new
uptrend from a solid base. I am looking for a breakout and major move to
start in the next day or two.
I would Buy CMGI here.
I would place a stop at 86 �.
