Sunday, August 12, 2007

Momentum

Momentum is an oscillator designed to measure the rate of price change, not the actual price level. This oscillator consists of the net difference between the current closing price and the oldest closing price from a predetermined period.

The formula for calculating the momentum (M) is:
M=CCP-OCP, where
CCP - current closing price
OCP - old closing price for the predetermined period.

The new values thus obtained will be either positive or negative numbers, and they will be plotted around the zero line. At extreme positive values, momentum suggests an overbought condition, whereas at extreme negative values, the indication is an oversold condition. (See Figure M1) The momentum is measured on an open scale around the zero line.



Figure M1. An example of the momentum oscillator

This may create potential problems when a trader must figure out exactly what an extreme overbought or oversold condition means. On the simplest level, the relativity of the situation may be addressed by analyzing the previous historical data and determining the approximate levels that delineate the extremes. The shorter the number of days included in the calculations, the more responsive the momentum will be to short-term fluctuations, and vice versa. The signals triggered by the crossing of the zero line remain in effect. However, they should be followed only when they are consistent with the ongoing trend.




7 comments:

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