- Dec 21, 2011
In the trading markets “momentum” is a word that is commonly used to describe the rate at which price trends are changing. Classically, a price “trend” is a series of prices that generally head in the same direction (up, down, or sideways). However, we know that prices do not trend in one direction forever. When any change in direction occurs, we say the prices changed momentum. The directional change need not be a reversal in direction. A trend change can just be a different slope or rate of change.
Imagine a car traveling at 60 miles per hour. The 60 miles per hour is its speed, or its travel “trend.” Should the car slow down, we say it is “decelerating.” It is still traveling in the same forward direction but at a slower speed, and to get to that speed, it had to decelerate. In markets, when the price trend is not rising as fast as it was at an earlier point, we say it is losing momentum, or decelerating. In prices, losing momentum can eventually result in a trend reversal. The car can stop and go backward. Changes in momentum thus occur before changes in direction, just as changes in the car acceleration or deceleration precede changes in direction. For this reason, we want to study momentum. It leads trends’ directional changes.
This is why price analysts so thoroughly study momentum in markets. If they can detect a change in momentum, they might receive a clue as to how the price trend will change direction in the future. Momentum is an early warning device in markets.
The traditional manner of measuring momentum is to calculate the change in prices from one period to another. If the change is constant, the momentum is neither increasing nor decreasing. If the change declines, we receive a momentum warning that a price decline may be ahead. Conversely, when momentum increases, we receive a warning that an advance may be ahead. You should be somewhat careful in interpreting momentum change, however. A change in momentum does not always bring a change in price direction. A momentum change can occur when the price trend slope is increasing or decreasing but not necessarily reversing.
Because prices are never rising or falling steadily but have intermittent oscillations back and forth, you must use a method that can measure momentum yet reduce the effects of the minor oscillations. Technical analysts do this by using moving averages.