Forex indicator momentum

First invented by Gerald Appel in the s, the MACD is one of the simplest, yet most effective, technical indicators around. When used in FX, it simply records the difference between the period exponential moving average EMA and the period exponential moving average of a currency pair.

When MACD crosses the nine-period line from the bottom, it signifies a change to the upside; when the move happens in the opposite manner, a downside signal is made. Although the histogram is in fact a derivative of a derivative, it can be deadly accurate as a potential guide to price direction.

The first and most important step is to define a MACD segment. For a long position, a MACD segment is simply the full cycle made by the MACD histogram from the initial breach of the 0 line from the underside to the final collapse through the 0 line from the topside.

For a short, the rules are simply reversed. Figure 1. Having noted the prior high or low in the preceding segment, you can then use that value to construct the model. If the MACD histogram now registers a downward reading whose absolute value exceeds 0. Once the MACD segment is established, you need to measure the value of the highest bar within that segment to record the momentum reference point.

In case of a short, the process is simply reversed. If the case were reversed and the preceding MACD segment were negative, a positive reading in the present segment that would exceed the lowest low of the prior segment would then signal a high probability long. Figure 2. The basic premise is that momentum as signified by the MACD histogram can provide clues to the underlying direction of the market.

Using the assumption that momentum precedes price, the thesis of the setup is simply this: a new swing high in momentum should lead to a new swing high in price, and vice versa. A new momentum swing low or high is usually created when price makes a sudden and violent move in one direction. What precipitates such price action? A belief by either bulls or bears that price at present levels represents inordinate value, and therefore strong profit opportunity. Typically, these are the early buyers or sellers, and they wouldn't be acting so quickly if they didn't believe that price was going to make a substantive move in that direction.

Generally, it pays to follow their lead because this group often represents the "smart money crowd. Not only will the setup sometimes fail outright by producing false signals, but it can also generate a losing trade even if the signal is accurate.

Remember that while momentum indicates a strong presence of trend, it provides no measure of its ultimate potential. In other words, we may be relatively certain of the direction of the move, but not of its amplitude. As with most trading setups, the successful use of the momentum model is much more a matter of art than science.

Looking at Entry Strategies A trader can employ several different entry strategies with the momentum model. The simplest is to take a market long or market short when the model flashes a buy or a sell signal. This may work, but it often forces the trader to enter at the most inopportune time, as the signal is typically produced at the absolute top or bottom of the price burst. Prices may continue further in the direction of the trade, but it's far more likely that they will retrace and that the trader will have a better entry opportunity if they simply wait.

Understanding what is occurring on the larger time frame is often very helpful in filtering out low probability trades. Looking for key support and resistance areas and using that as a backdrop to lean on a divergence setup can increase your odds of a winning trade substantially. During a trending market condition, you can also look for a pullback where price action is diverging from the Momentum indicator.

A divergence trade setup that is aligned with the overall trend is likely to provide a higher success rate, than bucking a strong trend and trying to pick a top or bottom. When attempting a counter trend trade with momentum divergence, it is important that you have additional evidence that a trend reversal is likely.

No matter how far a market has extended or how good a counter trend divergence signal looks, it could very well be a false signal, and the market could continue to trend. The first example below occurs within a range bound market.

Take note on the far right of the chart, price action makes a higher high and the Momentum Oscillator makes a lower higher. This is a good quality divergence setup that occurs within a range bound market condition. On the chart above, you will notice that price is in a strong downtrend. There are three Momentum divergence signals noted on the chart. All three proved to be false signals as price action continued to trend to the downside.

This should make you think twice about trading divergences during strong trends. Trading Strategy using Momentum Indicator By now you should have a good understanding of what the Momentum indicator is, how it is constructed, and some of the trading signals that it provides. We will now shift our focus and discuss some trading strategies that we can use when trading with Momentum. We have already outlined the details of the divergence pattern, so now I will briefly explain what a Zig Zag Pattern is.

It consists of three waves — A, B, and C. Wave A is the initial wave of the pattern, which is retracement by the second leg, Wave B. The final wave, Wave C, moves in the same direction as Wave A and must extend beyond it. Firstly, what we are looking for is an overall trending market. Secondly, we want to see a Zig Zag correction within that trending market. And then, finally we want to wait to see if a divergence formation occurs within the Zig Zag pattern.

If we can confirm the divergence between the Momentum indicator and price, then that will be our trade setup. Our actual entry signal will occur on the break of the trend line that extends from the beginning of Wave A and connects to the beginning of Wave C. We will call this the A-C trend line. As for trade management, we will look to place our stop loss beyond the most recent swing created prior to the A-C trend line breakout.

And for the take profit target, we will target an area just inside the beginning of Wave A. At some point, price action begins to turn up and soon we see a Zig Zag pattern forming on the chart. Also at the same time, we see that a Bearish Divergence pattern is forming as well between the price and the Momentum Indicator.

The dashed yellow lines represent the divergence formation. All of this evidence points to a possible reversal, so we want to be positioned to the short side. Recall per the strategy described, we would want to wait until we have a break and close beyond the A-C trend line of the Zig Zag pattern. You will notice the A-C trend line is marked with a dashed red line. Sometime after the divergence pattern has formed, we have a strong break and close beyond the A-C trendline.

This is the entry signal that we are waiting for, and we would want to initiate a short trade here. The stop loss would be placed just above the Pin Bar that was created several bars back. You can spot this by locating the bar with the relatively high wick to the upside. Just after the entry, price action tested the broken A-C trendline and then moved sharply to the downside. We would exit the trade just before price reaches the beginning of the Zig Zag pattern.

I have noted the take profit target area on the chart. Momentum Divergence with Support and Resistance Regardless of the trading system used, every trader should take the time to understand the fundamental concepts of Support and Resistance. Support levels are areas where price is likely to stall or find demand buying pressure. Resistance levels are areas where price is likely to stall of find supply selling pressure.

When a support level breaks, it turns into new resistance. When a resistance level breaks, it turns into new support. It is important to note that Support and Resistance should be viewed as zones or areas rather than a fixed line. One of the major mistakes that traders make is that they typically only look at one timeframe — their trading timeframe.

By doing this, they lose sight of what is going on in the bigger picture and sometimes trade right into a key support and resistance level without even knowing it. So, it is critical to know where major support and resistance areas are so that you can navigate your trading within that framework. In this next strategy, we will be combining the Momentum indicator using the divergence pattern again, but this time we will trade the divergence off of a key higher timeframe level. So, if you were trading the 60 minute chart, your key levels would be plotted off the minute chart, which is the next higher timeframe.

Or if you were trading the minute chart, your key levels would be plotted off the daily chart. Typically, the higher timeframe will be 4x to 6x your trading timeframe. Once we confirm the divergence between the Momentum Oscillator and price has occurred, then we will consider that a potential trade setup is progressing.

Our actual entry signal will occur on Momentum Indicator crossover. We will need to place a stop loss order in the market. For the stop loss, we will use the most recent swing prior to the Momentum crossover signal. For the exit, we will wait for the Momentum Indicator crossover in the opposite direction. Take note of the solid red line on the chart. That red line represents key resistance area for the 10 hr. Keep in mind for this strategy, we want to use the higher timeframe to mark major support and resistance levels.

As the down move began to subside, prices started to reverse and trade to the upside.

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