Trading Academy

Lesson 33

Momentum indicators

Momentum indicators reflect the speed at which prices are moving, either up or down. If an uptrend is backed by high momentum readings, the buying interest is thought to be very strong, while with a slower momentum, buying interest would be weaker. 

The indicators that gauge momentum are said to be leading indicators, because they precede the price movements and have predictive qualities. They typically fall in the category of technical indicators called oscillators, because they are plotted on a scale that reflects momentum rising or falling; in other words oscillating. 

The most popular momentum indicators are the Relative Strength Index (RSI) and the Stochastic, which both fluctuate between overbought and oversold conditions. Buying and selling signals are based on the upper and lower levels of the range.

 These oscillators are regarded as highly useful in non-trending markets, when the traders profit from divergence setups.

Note: just because an oscillator shows overbought or oversold conditions does not mean that prices have to reverse. Look for confirmation in price or in other indicators to avoid false signals.

Lagging Indicators

The second major category of the technical indicators are the lagging indicators. These are commonly used to spot trends that are starting or to confirm trends that are already in place. This category includes tools like Moving Averages, MACD and ADX.

A significant advantage with lagging indicators is that they give fewer false signals, which generally means that you are stopped out for a loss on fewer occasions.

The drawback in using lagging indicators is that a significant part of the move may have already occurred, and this translates into less profit and a potentially higher risk.

Keep in mind: each technical indicator will work better in some environments than others. Try them in different circumstances to better understand their functions and utility.

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