Momentum is a key factor in successful trading, but many new traders don’t really understand what it means.
Momentum in trading refers to the speed or strength of price movement in a particular direction.
Therefore, it makes sense that momentum trading is a strategy that aims to capitalise on these price movements.
Traders look to enter trades in the direction of the momentum, hoping it will continue.
This is a common strategy for both retail traders and prop traders.
In this article we take a take a look at all aspects of momentum in trading – how to measure it, the tools to use, and successful momentum trading strategies.
What is momentum in trading?
Momentum in trading refers to the tendency of an asset’s price to continue moving in its current direction.
It’s the idea that if an asset has been rising, it’s more likely to continue rising, and vice versa for a falling asset.
Momentum is a technical analysis concept that’s based on the belief that history tends to repeat itself.
If an asset’s price has been rising steadily, it’s considered more likely to continue rising.
Understanding momentum
Momentum is based on the idea that once a price trend is established, it is more likely to continue than reverse.
This concept stems from physics, where an object in motion tends to stay in motion.
Think of momentum like a rolling ball.
Once it starts moving, it tends to keep going in the same direction until something stops it.
In trading, the ball is the price of an asset, and the direction it rolls is the trend.
In trading, momentum builds as more participants join in on a strong price movement, causing the asset to keep rising or falling.
Traders track momentum using technical indicators and price patterns to try and predict future price movements. 
What is momentum trading in forex?
In forex trading, momentum trading focuses on currencies that are experiencing rapid price movements.
Momentum traders in the forex market aim to profit from short- to medium-term trends, typically triggered by news, economic data releases, or market sentiment.
After a significant interest rate decision or economic report, a currency pair may see increased momentum, which traders look to exploit.
For example, if the EUR/USD pair has been rising steadily, a momentum trader might buy more euros, expecting the trend to continue.
Timing is critical in forex momentum trading, as these movements can often be sharp but short-lived.
What is momentum trading in the stock market?
In the stock market, momentum trading involves buying stocks that are trending upward with high volume, and selling stocks that are trending downward.
Momentum traders look for stocks that are outperforming the overall market or their particular sector.
If a stock has been rising sharply, a momentum trader might buy it, hoping it will continue to appreciate in value.
Momentum in stocks is often driven by corporate earnings, mergers, or macroeconomic factors.
A stock with strong earnings growth, or a company experiencing rapid innovation may see increased buying pressure, creating upward momentum.
Conversely, negative news can create downward momentum, which CFD traders can also profit from by short selling.
How to calculate momentum
Momentum can be calculated by comparing the current price of an asset to its price a certain number of periods ago. The basic maths concept is:
Momentum=current price−price xxx periods ago
This calculation gives you the net change over a specified period.
A positive result indicates upward momentum, while a negative result indicates downward momentum.
However, most traders use technical indicators to confirm trends, indicate the strength of the momentum, and to time their entries and exits.
Personally, when trading, I’ve never manually calculated momentum, as there’s so many indicators which do the job for us.
Tools to use to measure momentum
There are several popular tools and technical indicators that traders use to measure momentum.
The ones we’ll focus on here are:
- Relative Strength Index (RSI)
- Moving averages
- Average Directional Index (ADX)
- Moving Average Convergence Divergence (MACD)
- Momentum indicator
I’ve always found the RSI and simple moving average lines give me the information I want for my style of CFD day trading.
Popular indicators to measure momentum
These are five of the most popular indicators that traders use to measure momentum.
I believe the ADX indicator is not the most helpful, and the MACD histogram confuses my brain!
However, it’s up to each individual to choose the momentum indicator they find works for their own style of trading.
1. Relative Strength Index (RSI)
RSI measures the strength and speed of price movement by comparing recent gains to recent losses.
It is a momentum oscillator that measures the speed and change of price movements over a specified time period, typically 14 periods.
It oscillates between 0 and 100, and is used to identify overbought or oversold conditions in the market.
Overbought/oversold levels:
- When the RSI rises above 70, the asset is considered overbought, indicating that the price may be due for a pullback or reversal.
- Conversely, when the RSI drops below 30, the asset is considered oversold, signalling a potential short buying opportunity.
Divergence signals:
The RSI can also signal potential reversals through divergence.
- A bullish divergence occurs when the price makes lower lows, but the RSI makes higher lows, suggesting weakening downward momentum.
- A bearish divergence occurs when the price makes higher highs, but the RSI makes lower highs, indicating weakening upward momentum.
Trend confirmation:
The RSI can also confirm trends. In a strong uptrend, the RSI typically stays above 50, while in a downtrend, it often remains below 50. This level can help you stay aligned with the dominant trend.
2. Moving Averages (MA):
Moving averages smooth out price data to show trends over time.
They are one of my favourite indicators!
They calculate the average price over a set number of periods, helping us identify trends and momentum.
The two most common types are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
The EMA gives more weight to recent prices, making it more responsive to current price action than the SMA.
We use SMAs and EMAs to identify momentum by observing whether prices are above or below these averages.
Moving averages are useful for:
- Trend identification: A simple moving average (SMA) can help identify trends. A rising SMA indicates an uptrend, and a falling SMA indicates a downtrend.
- Identifying MA crossovers: When a shorter-term moving average crosses a longer-term moving average, it can signal a potential trend change. For example, a 50-day SMA crossing above a 200-day SMA might indicate a bullish uptrend is about to start.
- Dynamic support and resistance: Moving averages can act as dynamic support or resistance levels. In an uptrend, prices may bounce off the moving average, using it as support, and in a downtrend, the moving average often acts as resistance.
3. Average Directional Index (ADX):
The ADX is a simple line indicator measuring the strength of a trend.
It ranges from 0 to 100, with values above 25 indicating a strong trend, and values below 20 suggesting a weak or non-trending market.
- Trend Strength: A high ADX value (typically above 25) indicates a strong trend, while a low ADX value (typically below 20) indicates a weak or no trend.
- Confirmation of other indicators: The ADX is often used in conjunction with other momentum indicators. For example, if moving averages or the RSI indicate a trend, the ADX can help confirm whether the trend is strong enough to trade.
- Avoiding false signals: During times of low ADX (below 20), it’s best to avoid using trend-following strategies, as the market may be moving sideways, increasing the likelihood of false breakouts or reversals.
4. Moving Average Convergence Divergence (MACD):
The MACD is a trend-following momentum indicator that shows the relationship between two moving averages, typically the 12-period EMA and the 26-period EMA.
It consists of the MACD line, the signal line (9-period EMA of the MACD line), and a histogram that displays the difference between the two lines.
- MACD line and signal line crossovers: When the MACD line crosses above the signal line, it generates a bullish signal, indicating upward momentum. When the MACD line crosses below the signal line, it gives a bearish signal, suggesting downward momentum.
- Histogram analysis: The MACD histogram measures the distance between the MACD and signal lines. When the histogram bars increase in size, it suggests growing momentum. A shrinking histogram indicates weakening momentum, signalling potential reversals or trend shifts.
- Zero line crossovers: When the MACD line crosses above the zero line, it confirms bullish momentum, while a cross below the zero line signals bearish momentum. This crossover can act as a secondary confirmation of trend strength.
5. Momentum Indicator:
The momentum indicator is a simple tool that measures the speed at which the price is moving.
Therefore, it measures the rate of change in an asset’s price.
It does this by comparing the current price to the price a specified number of periods ago.
A positive momentum reading indicates rising prices, while a negative reading shows falling prices.
- Trend confirmation: If momentum is positive and rising, it confirms that the asset’s price is increasing with strength. If it is negative and falling, it signals strong downward momentum.
- Divergence: Like the RSI, the momentum indicator can also signal potential reversals through divergence. A bullish divergence occurs when the price makes lower lows, but the momentum indicator makes higher lows. A bearish divergence happens when the price makes higher highs, but momentum forms lower highs.
- Exiting trades: Traders often use the momentum indicator to time exits. If you are in a long trade and notice momentum declining, it may indicate that the trend is losing steam, signalling an opportunity to exit.
Hints and tips on using momentum indicators:
Using momentum indicators effectively requires a combination of technical knowledge and strategic implementation.
Here are a few tips:
Confirm your signals
Don’t rely on just one indicator. Use multiple indicators to confirm the signal you are relying on to trade.
For example, you could use the RSI to identify overbought/oversold conditions, and the MACD to time your trade entry.
However, it can be tempting to add too many indicators to your charts.
Too much information can lead to ‘analysis paralysis.’
Therefore, I suggest you don’t ‘clutter’ your main trading chart with too many indicators all at once.
Focus on a few key indicators that align with your trading strategy, and stick to these.
Either use another tab for other indicators, or turn your indicators on and off again when they’re not being used.
Use indicators in conjunction with price action
Indicators should not be used in isolation.
They are most effective when combined with price action analysis, such as identifying support and resistance levels, trendlines, or candlestick patterns.
For example:
- Use the RSI or MACD to confirm a breakout from a key support or resistance level.
- Combine moving averages with price patterns like head and shoulders or double tops to validate trend reversals.
Know each indicators’ strengths
Each indicator has its strengths and limitations, so it’s important to know when and how to use them.
As you gain experience using indicators, you’ll soon find the ones that give you the best signals for your personal trading strategy.
Once you’ve identified one that works for you – stick to it! Don’t chop and change indicators too often.
- RSI: Best for identifying overbought and oversold conditions, but can generate false signals in a strong trending market.
- MACD: Great for confirming trend direction and momentum, but can lag during rapid price movements, as it uses moving averages.
- Moving averages: Useful for spotting trends, but they can also lag behind price, making them less effective in volatile markets.
- ADX: Ideal for determining trend strength but not the direction, so it should be used in conjunction with other indicators.
Adjust your indicator settings based on market conditions
Most indicators come with default settings, but adjusting these settings to suit different markets or timeframes can improve their accuracy.
- Shorter time periods make indicators more responsive to price movements, but can result in more noise and false signals.
- Longer time periods smooth out noise but may cause delays in signal generation.
For example, if you’re trading in a fast-moving market, you might shorten the settings of the MACD or moving averages to make them more responsive.
When I day trade CFDs, I use a 5-day SMA and a 20-day EMA, which I find gives me the perfect blend of responsiveness and sensitivity.
Conversely, for longer-term trends, a higher setting such as a 50-day SMA and 200-day EMA may give more reliable signals about longer-term trends.
Align indicators with your trading strategy
Tailor your choice of indicators to your specific trading strategy:
- For trend-following strategies, use indicators like moving averages and MACD to identify and confirm strong trends.
- For range-bound strategies, indicators like the RSI the Stochastic Oscillator or Bollinger Bands can help you spot overbought or oversold conditions, indicating when to buy or sell within a range.
- For momentum trading, focus on indicators like MACD, the momentum indicator, and RSI to capture rapid price movements.
Backtest your strategy
Before relying on an indicator for live trading, backtest it on historical data to see how it performs under various market conditions.
This process will help you:
- Understand how the indicator responds to different market phases (trending, consolidating, volatile).
- Fine-tune your indicator settings according to your trading strategy for better results.
- Identify whether the indicator provides early or late signals, and adjust your strategy accordingly.
Momentum trading strategies
Momentum trading strategies typically involve identifying strong price movements and entering trades in the direction of the trend.
Some common strategies include:
- Breakout trading: Enter a trade when the price breaks above resistance or below support, signalling the start of a new momentum phase.
- Pullback trading: Buy during a short-term dip in an uptrend, or sell during a temporary rise in a downtrend.
- Trend trading strategy: Wait for confirmation that a trend is still intact, using indicators like moving averages or MACD. Buy assets that are trending upward and sell assets that are trending downward.
How to start momentum trading – detailed steps
To begin momentum trading, follow these detailed steps:
- Choose your preferred forex pair or stock or cryptocurrency to trade: Decide whether you want to trade forex, stocks, or another asset class based on your personal preferences and experience.
- Develop a detailed trading plan: Outline your trading strategy, risk management rules, and entry and exit criteria. Remember – those who fail to plan, plan to fail.
- Identify the direction of momentum: Use technical indicators like the RSI, MACD, or moving averages to identify assets with strong momentum in a particular direction.
- Set your trade entry point: Establish an entry point, such as a breakout or pullback, to ensure you are entering trades in line with the trend.
- Decide on your stop loss position: Protect your trading capital by placing a stop-loss order to limit any potential losses, just in case the momentum direction reverses.
- Determine your exit point: Work out at what point you will exit your trade – either a set monetary value, or when an indicator shows a trend may be weakening or reversing.
- Work out your position size: Calculate the size of your trade based on a percentage of your trading account or other risk-management strategies.
- Monitor your trade: Keep a close eye on your trade to ensure the momentum continues in your favour. Be ready to exit if the trend weakens or reverses.
- Exit at the right time: Use technical indicators like RSI or MACD crossovers to identify when momentum is slowing, signalling it’s time to exit the trade.
- Review your trading strategy performance, and adjust it if required: Regularly review your trading performance, and make adjustments as needed. However, don’t make too many changes at once, otherwise you won’t know which change made the most difference.
The difference between trend following vs momentum trading
Trend following involves staying in a trade as long as the overall trend persists, even if there are short-term corrections.
In contrast, momentum trading focuses on capturing sharp, short- to medium-term price movements, often over a few days or weeks.
While both strategies involve trading with the trend, momentum traders aim for quicker profits by exploiting rapid price changes.
Trend traders tend to hold positions open for a longer period.
The difference between momentum trading vs swing trading
Momentum trading and swing trading both aim to profit from short-term price movements, but there are key differences:
- Momentum trading: Focuses on capitalising on strong price movements over a shorter time frame, often just a few hours or days.
- Swing trading: Seeks to profit from price swings over several days to weeks. Swing traders are more willing to hold positions through small corrections, while momentum traders aim to exit before momentum fades.
Final thoughts on momentum trading
Momentum trading can be a powerful strategy for those traders looking to profit from rapid price movements in the forex, stock, or crypto markets.
By using the right tools to measure momentum and following a solid strategy, you can take advantage of price trends and volatility.
However, momentum trading requires careful timing and risk management, as price reversals can occur unexpectedly.
With practice, patience, and a clear trading plan, momentum trading can form a valuable tool in your trading toolbox.
Till next time, happy trading!
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Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- Investopedia – Introduction to Momentum Trading: https://www.investopedia.com/trading/introduction-to-momentum-trading/
- Wikipedia – Momentum investing https://en.wikipedia.org/wiki/Momentum_investing
