The Momentum indicator is often used to spot and trade trends in forex strategies, but how effective has it been in trading major currency pairs in recent years of trading? This article will take a look at one method of trading using the Momentum indicator and how we might choose to apply it to our own strategies.
Momentum Indicator: What is it and how do we use it?
The Momentum Indicator is possibly one of the easiest to calculate and most straightforward indicators in all of technical analysis.
Momentum = Current Closing Price – Closing Price N Bars Ago
The sole input for the indicator is the length of look-back period—the “N” in the formula above. A longer look-back period creates a smoother line and gives the best sense of overall momentum for the currency pair. Yet a long look-back also operates on a clear delay and is less apt to catch fast shifts in price momentum. Most charting packages use “12” as the default look-back period for the Momentum indicator, and it seems to provide a reasonable compromise between timeliness and accuracy of trading signals.
Momentum Indicator on EURUSD Daily Chart
Generated using FXCM Strategy Trader
There are a wide variety of ways that traders use the Momentum indicator, but the vast majority of uses revolve around trading trends in some shape or another. In developing a trading strategy around this technique, we will likely want to develop trade entries that trade in the direction of the trend. Thus we propose the following trading rules to test the effectiveness of the momentum indicator in picking out worthwhile trend trading opportunities.
Given that we would like to trade in the direction of the trend, we will combine the concepts behind the momentum indicator with a straightforward stop-entry system of trading into fresh highs and fresh lows.
Forex Momentum Indicator Strategy
Entry Rule:When the 12-Period and 1-Period Momentum Indicator are above zero—confirming that overall momentum and very recent momentum point higher—place a stop entry order to buy at the previous bar’s high plus one pip. When both the 12-Period and 1-Period Momentum Indicator are below zero, place an order to sell at the previous bar’s low minus one pip.
Stop Loss: None by default
Take Profit: None by default
Exit Rule:Strategy will exit a trade when opposite signal is triggered.
Read more at: Forex @ DailyFX - Forex Strategy Corner: Using Momentum Indicator in Currency Trading http://www.dailyfx.com/forex/technical/article/forex_strategy_corner/2010/09/24/Forex_Strategy_Corner-_Using_Momentum_Indicator_in_Currency_Trading.html#ixzz11Dxk623R
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