Understanding momentum comes along with understanding the indicators that involved with this kind of trading. Momentum trading focuses on continuing momentum or weakening momentum as a way to position trades and meet trading goals. A momentum trader is likely to follow the charts and bet on a continuation of a trend, or place a short bet and go against the trend when momentum shows weakness. By nature, momentum trading usually involves significant bottom and top calling.
Momentum traders usually make use of custom indicators, typically oscillators that are refined to find runaway charts. Strategies for gapping up and down are preferred for momentum traders, as a gap shows strength or weakness, coinciding with their overall strategy. The basic trading fundamentals of momentum trading has much to do with finding current trends and riding them for their worth.
There are four pieces to the momentum puzzle. Each of these four indicators is very important to momentum trading mostly because they are all oscillators. Technical analysis, especially oscillators, is favorable because they move up and down with price.
Momentum
There is such a thing as just a momentum indicator. The indicator itself is very simple; it measures the rate of change in the closing price to determine in which direction the markets are moving, and to what degree. Momentum can also be used to show underlying weakness in a trend or detect reversal trends.
Rate of Change
Rate of change is a more complex form of the momentum indicator. The rate of change is centered around a central point to show the movements above and below the zero line. Finding how to generate profits with the rate of change is difficult; it works best in sideways markets rather than trendier markets. This isn’t an indicator to be used all the time in your analysis.
Stochastic
The Stochastic uses the rate of change, but adds in a smoothing element to make it very similar to the RSI. Stochastic technical analysis uses include selling above 80 and buying below 20, or using it as a convergence divergence indicator similar to the MACD or RSI. Proven trading strategies with the Stochastic are those that use the 80-20 rule, or modify it even heavier and buy at 90 and sell at 10 to hit just the extremes. Developing your own custom indicators for each is important to making the best of it; some prefer 70-30 while others like the other extreme – it all comes down to your trading goals.
RSI
The RSI focuses on the difference between the strength in uptrends and downtrends. The RSI is used much in the same way as the stochastic for momentum trading.
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