Momentum

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The momentum indicator is a simplified version of the ROC (Rate of Change). It measures the security's price change during a given time span.

The ROC is calculated by subtracting the closing price n periods ago from the closing price and dividing it by the closing price n periods ago:

ROC = (Close - Close N periods ago) / Close N periods ago * 100

The Momentum Indicator is calculated by subtracting the closing price n periods ago from the closing price:

Momentum Indicator = Close - Close N periods ago

As you see, the ROC is a percentage representation of the Momentum Indicator. Like the ROC, the Momentum Indicator provides an indication of a market's velocity and, to some degree, a measure of the extent to which a trend still holds true.

The Momentum Indicator can be used to spot possible reversal points. Both the Momentum Indicator and the ROC can be used as trend following (lagging) indicator in a way similar to MACD: buy when the indicator starts to move up after hitting a bottom and sell when the indicator starts to decline after hitting a top.

For any indicator in technical analysis, we always recommend that you compare the current indicator's readings to the historical critical and extreme levels. The Momentum Indicator is not an exception to this rule. When the Momentum indicator hits extremely high or low values in relation to the historical readings, there is a strong possibility that there will be a continuation of the current trend rather than a reversal.

The Momentum indicator can be used as a leading indicator as well. In many cases, the Momentum indicator will rally upwards sharply before a reversal downwards, and decline sharply before a reversal upward.

Chart 1: Dow Jones Industrials (^DJI) - Momentum and ROC