One of the main goals of every trader using technical analysis to measure the strength of asset’s momentum and the likelihood that it will continue. This is the main goal of indicators such as moving average convergence-divergence (MACD), stochastic oscillator, rate of change of price (ROC) and relative strength index (RSI).
Most of the indicators used to measure the impulse is interpreted with the help of certain values, which suggest the asset might be overbought or oversold. The current momentum is considered to be weakened when indicators such as those mentioned above have values that demonstrate the conditions of overbought and oversold. For example, many traders believe that the asset the RSI is below 30 or the stochastic value below 20 may be a reduction in the number of downside momentum and a likely candidate for reversal.
You may notice that many momentum indicators are connected between the two extreme levels, usually from 0 to 100 or from -100 to +100. This is important because to cross the center line indicator means that the momentum increases or decreases, depending on direction. For example, momentum is increasing when the indicator crosses above the line 0, and decreases when it passes through 0.
To dig a little deeper into this particular technical indicator, the rate of change rate of change of variables over a certain period of time. It generally can be expressed as the ratio between the change in one variable relative to the corresponding change in the other. Graphically, the rate of change is the slope of the straight or horizontal median called equilibrium. This median that tells us everything you need to know about rate of change.
The normal time frame for ROC measurement is 10 days. The ratio for the construction of the ROC indicator is as follows: the rate of change is 100 (g/g).
“Y” represents the most recent closing price, and yx represents the closing price for a certain number of days ago. So if stock price will close higher today than it was 10 days ago, the point of the ROC value will be above the equilibrium, thus indicating to chartists that prices are rising in this particular matter. Conversely, if the price of today’s session closes lower than it was 10 days ago, the point value will be below the equilibrium, indicating that prices are falling. It’s safe to say that if ROC is rising, it gives a short-term bullish signal and bearish sign would be the ROC falls. Chartists pay great attention to the period of time in the calculation of the ROC. Long-term views of the market or a specific sector or stock will use perhaps a 26 – to 52-week period yx and a shorter view would use 10 days to six months.
In addition to ROC and other methods we have mentioned that traders can follow the specific intersection of moving averages to confirm the strength of price movement. Momentum is increasing when the short average crosses above the long term average. This is the promise of the MACD indicator, which uses a 12-day exponential moving average and 26-day EMA. When this indicator is greater than 0, this means that the short-term average above the long term averages, and this may mean that momentum is increasing.
To learn more about momentum trading, see Introduction to types of trading: momentum traders and momentum trading with discipline.