Technical Analysis 101 | The Best Momentum Indicators
Measuring the speed and strength of an asset.
Traders use momentum indicators like crooked police use speed radars on the side of a highway. They use them to spot fast movements to take advantage of with the goal of pocketing the cash. But momentum indicators measure the increasing speed of prices in your charts, not your car.
How do they work?
Momentum indicators measure the price speed by comparing the current price level with a price a given periods ago. The bigger the difference is between these two prices, the faster it moves and the more momentum it has.
Normally, these indicators assign values between 0 and 100 to analyze the speed of price movements.
For instance, if the assigned value of the current price is 50, and the next one is 52, and the one after is 56, we can deduce that that price is increasing its velocity and that it is trending stronger with every candle, therefore indicating increasing momentum.
Momentum indicators are widely used by professional traders to pinpoint oversold and overbought zones, and calculate the strength of a trend. Some of the most common ones are the following:
Stochastic is an indicator that, according to its creator George C. Lane, “follows the speed or the momentum of the price. As a rule, the momentum changes direction before price.”
The indicator measures if a certain stock is overbought or oversold. It will give out a buying signal when it is oversold and a selling signal when overbought. In order to identify these two zones, the Stochastic sets a range from 0 to 100 in which it will identify a price as oversold when the price is lower than 20 and as overbought when it's higher than 80.
Stochastic measures the closing point of the current candle and compares it to its highest and lowest point. If the closing price is near the highest point of the period, the indicator will give a signal that the stock is overbought and vice versa. After, the Stochastic will indicate how strong the actual trend is by comparing the current level with the past ones.
The Relative Strength Index (RSI) and Stochastic have similar functions but are calculated differently. RSI will look at recent price changes in order to determine if the current price is oversold or overbought.
It sets a similar range from 0 to 100 and assigns values for the oversold and overbought areas. However, in the case of the RSI the values are set at 70 and 30. Values above the 70 line would suggest that the price is overbought and give a sell signal, while below 30 it gives a buy signal.
RSI suggests that when levels are above 50, demand is pressuring more. But once it goes above 70 the price has gone up so much in comparison to its previous levels, that it is considered overbought and can be a good opportunity to short-sell. The same happens with values below 50, but of course, the other way around.
As can be seen in Figure 2, upward trends RSI values are normally above 50 and for downward trends below 50. As the chart shows, every time the RSI value goes above 70, the price does a pull-back to the previous support, since it is overbought. But if afterward, this value remains above 50, the trend still has enough strength to keep going up. Same with oversold values.
Swing trading involves trying to identify market trends. You would usually do this by opening positions for a couple of days to weeks or even months. Unlike scalping it requires patience.
Swing traders attempt to follow intermediate-term market developments. They benefit from volatile conditions since they look for higher potential profits margins. The crypto market is, therefore, a fruitful environment for swing trading since it creates a high number of these investment opportunities.
The benefits of swing trading are that is has a comparatively low stress-level, can be done in your part-time and has low brokerage costs since only a few trades are executed. This makes it a suitable place to start for beginners in trading.
Naturally, swing traders also have a repertoire of technical analysis tools and diligently study charts. The core idea here is to utilize the technical analysis for finding local bottoms (entry point) and local tops (exit points). Even though you may have a longer time-orientation than scalp traders and day traders, examining the aforementioned oscillators such as the Relative Strength Index will also be key. Alternatively, you could keep an eye on “Moving Average” indicators. These can allow you to sense trends by analyzing market conditions based a moving mean. One widely used example is the Exponential Moving Average (EMA). The EMA predominantly focuses on recent data points and is, therefore, said to be more useful than other moving averages for identifying entry and exit points.
Stochastic RSI (StochRSI) is a combined indicator and is formed from the Stochastic and RSI indicators. StochRSI applies the Stochastic formula to RSI values, instead of the prices.
Its value range between 0 and 100, in which values below 20 are considered oversold and 80 overbought. Other values like 50 can be used in a trading strategy to pinpoint upwards and downwards trends, as explained in the previous indicator.
StochRSI works in a very similar way as the two indicators previously explained. It is designed to enhance sensitivity and generate more signal than these two indicators separately.
Overbought and oversold levels for each of these indicators are an approximation. All cryptocurrencies or stocks will not behave in the same way for these levels. Because of this, you might want to fine-tune them when creating and configuring your strategy, in the case you use a bot to carry it out, as represented in Figure 1.
In short, momentum indicators don’t follow trends or volume but are very helpful to the speed of the price and strength. Combining them with other types of indicators such as trend following indicators might give strong trading signals. Cryptohopper includes several momentum indicators on its platform. Next to the ones represented above, you can use Momentum, Chaikin oscillator, DMI, CCI, MFI, PPO, ROC, Ultimate oscillator, and Williams %R.
In future blogs, combinations of indicators to design your trading strategy will be introduced and explained. Then, you will be able to backtest your potential strategies and adapt them to your own style. Happy Hopping!