Appreciating Momentum

By: Christopher Fitch

When it comes to security price momentum, many people will look at the general trend of a security without fully understanding the technical basis of the term. What Momentum really tells us, however, is whether the trend will continue or reverse. Without technical analysis and events like Momentum, many investors would buy high and sell low.

What Is Momentum Similar to the Moving Average Convergence-Divergence (MACD) oscillator, Momentum measures how much a security's price has changed over a given time. With a understanding of technical analysis and this particular event, investors will understand whether a slight pull back in price is part of the normal fluctuations of stock prices or if it is indeed a bearish signal for the price.

Put another way, Momentum gives investors insight into the underlying price trend. When using technical analysis tools in this manner, investors should be able to better identify whether a particular security is overbought or oversold and make changes to their positions accordingly. Decisions like these are impossible to make when based entirely on security prices.

Calculating Momentum One of the downfalls with technical analysis is that there is a heavy mathematical component to many of the events. While this not entirely true for Momentum, investors will need to understand the basic formula required to obtain a Momentum reading. Simply, Momentum is calculated by dividing the Closing Price by the Closing price ten periods ago, and multiplying it by 100. [Close/(Close 10 time-periods ago) * 100].

Using Momentum To Make Trade Decisions For help deciding on a Momentum-based trade, the investor must simply determine whether the Momentum value is greater than or less than zero. For amounts higher than zero, the a bullish signal is triggered and for amounts less than zero, a bearish signal is triggered. As a caveat, investors also need to understand that progressively higher low values might suggest a continuation of an existing trend and not a reversal. In most instances, investors should only execute a trade if the price itself turns around (e.g. on a sell, don't sell based on Momentum, but sell when the price begins to fall).

As with most technical analysis, investors should never base entry or exit points solely on Momentum. In many cases, Momentum can serve as confirmation of other technical events or even underlying security fundamentals.

As mentioned previously, many events triggered through technical analysis involve heavy mathematical calculations. For most investors who do not have the time or ability to complete their own mathematical work, trading software has evolved to the point where your computer will go so far as making simple buy and sell recommendations. Understanding technical analysis is one thing; completing the work is another. For most serious investors, trading software not only makes sense, but it improves profit.

Article Source: http://yourfinance.co.za

About The Author
Christopher Fitch manages the latest website about Investment Management at the MutualFundSite.org. as well as a the website about Fixed Rate Savings at FixedRateSavings.net.