There are many market indicators divided into 6 categories (trend, momentum, volatility, market strength, support/resistance and cycle). That being said some are very technical, some are infrequently used and some are more effective than others.
At its most fundamental level, momentum is a means of assessing the relative levels of greed and fear in the market at any given point in time. Securities ebb and flow, surge and retreat, and such action is measured by oscillators which are powerful leading indicators of the pair’s immediate direction and its speed.
Oscillators are most useful and issue the most valid trading signals when their readings diverge from prices. A bullish divergence occurs when prices fall to a new low while an oscillator fails to reach a new low. This situation demonstrates that bears are losing power, and that the bulls are ready to control the market for the pair again and such divergence often marks the end of a downtrend. Bearish divergences signify up-trends, when prices rally to a new high while the oscillator refuses to reach a new peak. In this situation, bulls are losing their grip on the pair, prices are rising only as a result of inertia, and the bears are ready to take control again.
Oscillators are most useful and issue the most valid trading signals when their readings diverge from prices. A bullish divergence occurs when prices fall to a new low while an oscillator fails to reach a new low. This situation demonstrates that bears are losing power, and that the bulls are ready to control the market, again and such divergence often marks the end of a downtrend. Bearish divergences signify up-trends, when prices rally to a new high while the oscillator refuses to reach a new peak. In this situation, bulls are losing their grip on the market, prices are rising only as a result of inertia, and the bears are ready to take control again.
The 6 Most Useful Momentum Indicators
1. Stochastic Oscillator (SO)
– compares a pair closing price to its price range over a given period of time. The theory behind this indicator is that in an upward-trending market, prices tend to close near their high, and during a downward-trending market, prices tend to close near their low.
There are two components to the SO: the %K which is the main line indicating the number of time periods (usually 14), and the %D which is a three-period moving average of the %K. Buy/sell signals occur when the %K crosses above/below the %D. A %K result of 70 (or 30), for example, is interpreted to mean that the price of the pair closed above 70% (or below 30%) of all prior closing prices that have occurred over the past 14 days and assumes that the pair’s price will trade at the top (or at the bottom) of the range in a major uptrend (or downtrend). A move above 80 suggests that the pair is overbought and therefore should be sold while a move below 20 suggests that the market is oversold and, as such, is a buying signal.
Using the two together gives traders an opportunity to hold out for a better entry point on an up-trending market or to be more sure that any down-trend is truly reversing itself when bottom-fishing for long-term holds.
2. Relative Strength Index (RSI)
– compares the magnitude of recent gains in price to recent losses in an attempt to determine overbought and oversold conditions of a pair.
The RSI, on a scale of 0-100, indicates that a pair is overbought when it is over 70 and oversold when it is below 30. Because large surges and drops in the price of a pair will create false buy or sell signals the RSI works best when it is used in conjunction with short-term moving average crossovers such as the Stochastic Oscillator to confirm a directional shift.
– created by applying the Stochastic Oscillator to the Relative Strength Index values rather than standard price data thereby giving the trader a better idea of whether the current RSI value is overbought or oversold – a measure that becomes specifically useful when the RSI value is confined between its signal levels of 30 and 70.
– displays the percent rate-of-change of a triple exponentially smoothed moving average of a pair’s closing price and is designed to filter out pair movements that are insignificant to the larger trend of the pair.
The user selects a number of periods (such as 15) with which to create the moving average, and those cycles that are shorter than that are filtered out. TRIX is also a leading indicator and can be used to anticipate turning points in a trend through its divergence with the pair’s price.
5. Commodity Channel Index (CCI)
– an oscillator which quantifies the relationship between the pair’s price, a moving average of the pair’s price, and normal deviations from that average to determine when a pair has been overbought or oversold.
The CCI, when used in conjunction with other oscillators, can be a valuable tool to identify potential peaks and valleys in the pair’s price, and thus provide investors with reasonable evidence to estimate changes in the direction of price movement of the pair.
6. Price Rate of Change (ROC)
– measures the percentage rate of change, indicating the strength of the momentum, between the most recent price and the price over “x” periods (the narrower the better) thereby identifying bullish or bearish divergences. As such, the ROC is able to forecasts sooner than almost any other indicator an upcoming reversal of a trend and whether or not a pair’s price action is created by those over-buying or over-selling it. A number other than zero (a personal choice) can be used to indicate an increase in upward momentum and a number less than zero to indicate an increase in selling pressure.
– used to forecast the future movements in the price of a pair such as when moves above (bullish) or below (bearish) its 20-day moving average.
When a pair’s long-term moving average (e.g. 50-day ma or ema) moves above its short-term moving average (e.g. 20-day ma or ema) it is referred to as a Death Cross and indicates a bear market on the immediate horizon, especially when it is reinforced by high trading volumes. Conversely, when a pair’s short-term moving average moves above its long-term moving average, coupled with high trading volumes, it is referred to as a Golden Cross and indicates a bull market on the immediate horizon.
2. Moving Average Convergence Divergence (MACD)
– a trend-following momentum indicator of the exponential moving average (ema) of a pair which is used to identify short-term momentum. Specifically, the 26-day ema of a pair is subtracted from the 12-day ema to show an intermediate trend line. A 9-day ema, the ‘signal line,’ is then plotted over that intermediate term line to identify when to buy or sell the pair. When the resultant MACD falls below the signal line, it is a bearish signal, which indicates that it may be time to sell.
Conversely, when the MACD rises above the signal line, the indicator gives a bullish signal, which suggests that the price of the asset is likely to experience upward momentum. Many traders wait for a confirmed cross above the signal line before buying or selling to avoid doing so too early and thereby avoid being ‘faked out’.
Traders also watch for a move above or below the zero line because this signals the position of the short-term average relative to the intermediate-term average. When the MACD is above zero, the short-term average is above the intermediate-term average, which signals upward momentum. The opposite is true when the MACD is below zero. The zero line often acts as an area of support and resistance for the indicator.
3. Percentage Price Oscillator (PPO)
– similar to the MACD but while the MACD shows the simple difference between the 2 exponential moving averages the PPO expresses this difference as a percentage which allows a trader to compare pair with different prices more easily.
For example, regardless of the pair’s price, a PPO result of 10 means the short-term average is 10% above the intermediate-term average. That makes it much easier to choose one pairover another should the need arise.
4. Keltner Channels
– moving average bands/channels where the upper line represents the average high of a pair over a 10-day period; the lower band the average low of a pair over a 10-day period and the centre line the closing price of a pair over the same 10-day period.
The trader is to sell the pair when the closing price exceeds the upper band and to buy the pair when the closing price falls outside the lower band. Like the other indicators mentioned it is best to add two or three other indicators to one’s charts to confirm any buy/sell signal.
5. Parabolic SAR
– used to determine the direction of a pair’s momentum and the point in time when this momentum has a higher-than-normal probability of switching directions.
The parabolic SAR is shown as a series of dots placed either below a pair’s price on a chart (a bullish signal causing traders to expect the momentum to remain in the upward direction) or above (a signal that the bears are in control and that the momentum is likely to remain downward).
As the price of the pair rises, the dots will rise as well, first slowly (i.e. spaced well apart) and then picking up speed (i.e. getting closer and closer together) and accelerating with the trend. This accelerating system allows the investor to watch the trend develop and establish itself. The SAR starts to move a little faster as the trend develops and the dots soon catch up to the price line and that is when it is time to buy the pair. A sell signal is triggered when the price line moves below the lower dot enabling an investor to position a stop-loss order.
The ability for the parabolic SAR to respond to changing conditions removes all human emotion and allows the trader to be disciplined. On the other hand, while the SAR works extremely well when a pair is trending, it can lead to many false signals when the price moves sideways or is trading in a choppy market. That being the case, it is paramount that other indicators such as the stochastic oscillator, moving averages, etc. be used to ensure that all information is being considered.
6. Traders’ Index (TRIN)
– a short-term breadth indicator which measures the ratio of advancing pair's to declining pair's and compares it to the ratio of advancing volume to declining volume.
When advancing volume exhibits discordance with the raw number of advancing pair's, the all-important sell signal is given. Conversely, when volume on the downside increases out of proportion with the number of declining pair's, an upside reversal is said to be imminent.
It is important to note that TRIN is handled differently in each of the different market conditions. In a bull market, the overbought line is placed at 0.65 or 0.70 but in a bear market at 0.70 or 0.75. The oversold line is placed at 0.90 or 0.95 in a bull market and at 1.00 or 1.10 in bear markets. Assuming the market has been correctly identified as a bull or a bear and the overbought and oversold lines have been correctly placed you should buy when the current TRIN crosses above its oversold line and sell when TRIN sinks below its upper overbought line.
When interpreted properly, TRIN can be one of the most powerful and accurate means of assessing the psychology of the market.
7. Advance/Decline Line (A/D)
– used to confirm the strength of a current trend and its likelihood of reversing. If the markets are up but the A/D line is sloping downwards, it’s usually a sign that the markets are losing their breadth and may be setting up to head in the other direction. If the slope of the A/D line is up and the market is trending upward then the market is said to be healthy.