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Using Intraday Momentum

Many traders are unfamiliar with the momentum indicator or with its value as an aid in timing. Although many have heard the term, they are not aware of how it is calculated, nor are they familiar with its applications.

Momentum is a very simple indicator which is easily calculated. In order to calculate the 1-day momentum (MOM), simply subtract today's price from yesterday's price. The result is a 1-day MOM. Therefore, if today's price is $52 and yesterday's price is $53, then the 1-day momenВэtum would be -1. If today's price is $52 and yesterday's price was $50, then today's 1-day momentum would be +2.

As you can see, the calculation of a 1-day momentum index is extremely simple. To calculate a 2-day momentum index, subtract the price 2 days ago from today's price. For calculating 3-, 4-, 5-day momenВэtum, follow the same procedure.

Momentum is a rate change indicator, since it provides you with an idea of trend strength. When momentum is moving down very quickly, it is an indication that prices are changing rapidly on the down side with large price moves. When momentum is rising rapidly, it is an indiВэcation that the market is trending strongly higher. Momentum can be used as a trading indicator by applying some simple rules.

This chapter will illustrate some suggested applications of intraday momentum for the purpose of day trading. I will show you some very interesting applications of momentum; however, I stress at the outset that these are merely applications and not systems. They are trading techniques which you will need to work with and refine. I believe that they have considerable potential, but they will require work.

Figure 9-1 shows an intraday price chart versus a 21-day momentum indicator. As you can see, MOM is like an oscillator. It fluctuates above and below a zero line. When MOM crosses from negative to positive, an uptrend is likely, and when it crosses from positive to negative a decline is likely.

As with most oscillators, MOM is good at finding trends; however, it gives many false signals as it "flutters" above and below zero. RegardВэless of this limitation, MOM can be used very effectively for position and day trading by comparing it to its first derivative. This is a simple procedure. All we need to do is to plot MOM against a moving average of itself (which is its first derivative).

Figure 9-2 shows the same market as Figure 9-1 but with an 18-period MA of the 21-period MOM. As you can see, by buying and selling when MOM crosses above and below its MA line, many of the false start signals are eliminated.

In addition to the use of a moving average of MOM to determine its first derivative, you can use other indicators such as RSI, stochastics, or rate of change (to be discussed in Chapter 10). Figures 9-3 through 9-7 illustrate some of the derivative methods and their signals as used in day trading. The methods and applications discussed in this chapter hold great promise as timing indicators and trading systems; however, considerably more research must be completed before firm conclusions can be reached.

As you can see, there are several potentially effective derivatives of the momentum indicator which may be used to decrease the number of false signals. The research on these combinations is still very sparse, and I encourage those interested in refining their day-trading techniques to investigate these combinations more thoroughly.