Technical analysis of a price chart is an evolving science. There are no limits or restrictions on combining multiple indicators and patterns to identify future price movements.
However, there are two basic elements in technical analysis, which everyone has to start with—first, identifying and drawing support and resistance levels, and second, analyzing momentum indicators.
We have covered the basics of support and resistance in one of our previous articles, which you can read here. This blog article will look at some key momentum indicators that you should follow and will show you how to use them to identify trends.
- The momentum indicator helps to measure the strength or weakness in the asset’s price trend.
- It also helps to get a better understanding of the rate of change in security’s price and direction.
- Popular momentum indicators include MACD, RSI, Stochastic, Bollinger Band, ROC, etc.
- You can combine multiple momentum indicators to accurately analyze the market trend
What’s a Momentum Indicator?
Momentum indicators are technical analysis tools that show the strengths and weaknesses of the stock or crypto’s price trend. It helps investors know the rate of speed at which a stock or crypto’s price may fall or rise in the near future. Based on the trend strength indicated, a trader may place buy or sell orders to profit from the price movements.
Below are the top five momentum indicators that help traders measure the strength in a security’s price trend.
Top 5 Momentum Indicators
- Moving Average Convergence Divergence (MACD)
- Relative Strength Index (RSI)
- Stochastic Oscillator
- Rate of Change (ROC)
- Bollinger Band
Moving Average Convergence Divergence (MACD)
MACD is one of the key technical indicators that every trader follows due to its accuracy in depicting strength in price trends. It consists of two lines—the MACD line and the signal line.
To get the MACD line, 26 EMA* is subtracted from 12 EMA, and the resultant value is plotted in the graph. And the signal line is the 9 EMA.
The MACD indicator is fairly easy to understand. A buy signal is generated, and the momentum is considered strong when the MACD line crosses the signal from below. And, when the MACD line crosses the signal line from above, it is considered to be a signal to start selling.
*Exponential Moving Average
The blue line represents the MACD line in the chart above, whereas the red one represents the signal line. If the former goes below the baseline and stays in the zone, the momentum in the market is considered to be weak and selling is likely to persist. In a buy signal, the MACD line needs to break above the baseline to confirm the uptrend.
Relative Strength Index (RSI)
RSI measures the magnitude of recent price change and determines whether the security is overbought or oversold. It is displayed as an oscillator in the chart, moving between two extreme points, 0 and 100.
An overbought condition is when the security’s price makes an extended up move and trades above its fair value, and the opposite of overbought is oversold.
The RSI line below 30 indicates an oversold condition, and the price of a security should move up from here due to the absence of sellers. If the RSI line crosses 50, it indicates an uptrend movement, but if it crosses above 70, it indicates an overbought condition, and the security’s price can fall from here.
In the chart above, the purple line indicates the RSI line. RSI remains in the 40–90 range in an uptrend market, with 40–50 acting as a support zone. While in a downtrend market, the RSI line stays between 10 and 60 range, with the 50–60 zone acting as a resistance.
A Stochastic Oscillator helps to identify the overbought and oversold condition in a security’s price by comparing closing price over a set number of periods. It tracks the momentum and speed in the change of security’s price and doesn’t consider volume.
The stochastic oscillates between the range 0 and 100, in which a value above 80 is considered overbought, while below 20 is considered oversold.
In the chart above, you can see two lines: the blue one is stochastic, while the orange one is the three-period simple moving average, which is referred to as “%D”.
A divergence between the stochastic oscillator and security’s price action is also an important reversal signal. For example, when the security’s price is in an uptrend and making new higher highs, but the oscillator is in oversold condition or falling, it may indicate that bulls are slowly losing their grip, and a bearish reversal might happen soon.
Rate of Change (ROC)
An ROC momentum indicator indicates the speed at which the price of variable changes over a specific period and represents the underlying momentum.
A security with a positive ROC indicates a high momentum and is likely to experience an increase in value, whereas a negative ROC indicates a weak momentum, which is considered a sell signal.
A Bollinger Band is a key momentum indicator that helps a trader understand the market’s current trend and volatility.
It consists of two bands, upper and lower bands, separated by a median line of 20 SMA. The upper and lower bands are plus or minus two standard deviations from 20 SMA.
*SMA= Simple Moving Average
The price closer to the upper band is considered an overbought market and vice versa. And the median line, the 20 SMA, acts as a support and resistance line. Before a trend reversal is about to happen, you can witness the narrowing of the band, followed by its widening in the direction of the trend reversal.
A security’s price always stays within the bands, and the trader gets cautious when the price stays in contact with either side of the band for a very long time. Combining MACD and RSI with Bollinger Band while analyzing trends will provide more accurate trade signals.
As traders, if we weaponize momentum indicators to their advantage, they can give us huge wins. Also, don’t blindly rely on anyone’s momentum indicator. We recommend that you use more than one of them to confirm the trend and reduce the risk of trading the false-positive or negative breakouts.
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Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.
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