Find the Truth Behind the Trend with the MT4 Momentum Indicator
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This article will provide you with insight for the MetaTrader 4 (MT4) Momentum Indicator, demonstrating how to use the Momentum Indicator in MT4, how to use the MT4 Momentum indicator with a trading strategy, how to use the MT4 Momentum Indicator as a confirming tool, and some general background for what the MT4 Momentum Indicator is.
One of the key concepts in technical analysis is the idea of trend. Many strategies rely on identifying whether the market is in a trend or not — and from there, working out if a trend is beginning or coming to an end. Knowing whether a trend is starting up or just about to break down is an extremely useful piece of information to have at your disposal. Part of knowing whether a trend will continue comes down to judging just how much gusto lies behind the move. This strength behind the trend is often referred to as momentum, and there are a number of indicators that attempt to measure it. Some of the better-known momentum indicators are the Relative Strength Index (RSI), the Stochastic oscillator and the Moving Average Convergence Divergence (MACD). You can read more about the MACD and other useful indicators in our list of the Most Important Forex Indicators.
RSI and Stochastic are both oscillators, meaning that their values move between a bounded range (often between 0 and 100). This article is going to discuss another momentum oscillator that some argue is just as effective as its more famous counterparts. This is the momentum indicator, which plots a curve that oscillates either side of a centreline value of 100. Like the RSI and the Stochastic, the momentum indicator can help to identify when a market move is overbought or oversold. That is, to show whether enough momentum remains behind a trend to keep the price-move going. When a falling market is oversold, it may be about to bounce. When a rising market is overbought, it may be about to fall.
Using the Momentum Indicator in MT4
The momentum indicator comes as one of the standard indicators that are available as part of the default version of MT4. The calculation behind the momentum indicator is fairly straightforward. The indicator works by making a comparison between a certain price, and the price of a set number of periods before that. The first step is to choose a value for N, i.e. the number of periods that will be used for the comparison. The momentum MT4 default value for N is 14, but you can set it to whatever value you wish.
The two comparison prices are the closing price of the current bar, and the closing price N bars ago. The formula for momentum is then as follows:
- Momentum = (current close/close N periods ago) x 100
The good news is that MT4 performs the calculations instantaneously, and displays it for you in a supplementary chart below your main chart.
This is how it looks:
Source: MT4 - GBP/USD Chart - Data Range: 6 Mar, 2017 - 13 Mar, 2017
In the hourly GBPUSD chart above, you can see that the momentum indicator has been added, which appears as a single blue line at the bottom. The peaks and troughs of this line reflect key shifts in the momentum of the Forex rate (Note that MT4 does not mark the centreline of 100). You can see that over the course of our chart, the momentum indicator varies from about 100.60 down to 99.44. The further above 100, the faster the price moves upward. The further below 100, the faster the price moves down. As we mentioned before, the momentum indicator is one of several trend-gauging oscillators available with MT4. You also have access to RSI and Stochastic. As a side note, there are other momentum indicators out there, such as the MT4 Stochastic Momentum Index (SMI), but you will have to download these as custom indicators if you are interested.
Using the Momentum Indicator as Part of a Momentum Trading Strategy
You can use the momentum indicator to provide trading signals directly, but it is more commonly used as a confirmation tool. The simplest signal is to take any cross across the centreline as a signal, buying when the value rises from beneath 100 to above, and selling when it drops below 100 from above. This is a rudimentary approach however, and should be considered with great caution. The timing of such signals can be difficult, meaning that you miss most of the move by the time the signal arrives. The timing can, however, be improved with the use of a moving average in conjunction with the momentum indicator.
How to Add a Moving Average to the Momentum Indicator in MT4
Some traders like to smooth the momentum curve using a simple moving average (SMA). You can do this by clicking on 'Moving Average' in the selection of 'Trend' indicators in MT4's navigator, and then dragging and dropping it into your Momentum Indicator chart. This will bring up a typical dialogue box. In the 'Parameters' section choose 'First Indicator's Data' from the 'Apply to' dropdown menu as shown below:
Source: MetaTrader 4 - Moving Average
The image below shows the SMA added to the momentum indicator as a red line:
Source - MetaTrader 4 - Momentum Indicator
The trading strategy now shifts, whereby the trader will buy when the momentum line crosses above the SMA, and sell when it crosses below the SMA. This should improve the timing of the signal slightly, but still has the drawback of offering many false signals.
Using the Momentum Indicator as a Confirming Tool
The indicator really comes into its own when used as a means of confirming signals from a separate, primary indicator. One of the best momentum indicator methods is to look for divergence between price and momentum, as a way of measuring the strength behind a move. So your buy or sell signal would come from whatever you have chosen as your primary indicator. You would then seek to confirm the signal via the momentum indicator, by looking for whether the price/momentum divergence is either bullish or bearish. Bullish divergence suggests an oversold market. If the price falls to new lows, but the momentum indicator fails to make new lows, this is known a bullish divergence. Bearish divergence suggests an overbought market. If the price rises to new highs but momentum fails to make a new high, this is known as a bearish divergence.
You would only follow a buy signal from your primary indicator when this is confirmed by bullish divergence from your momentum indicator. Similarly, you would only follow a sell signal when this is confirmed by bearish divergence. It's often useful to combine dissimilar indicators in this way, so that the differing aspects in their methods complement each other. Another example of this is combining momentum with volatility measures to form a squeeze momentum indicator.
Bollinger Bands provide a guide to volatility, widening in times of high volatility and narrowing when volatility is low. A Bollinger band squeeze is when volatility narrows to a historically low level. Such periods are likely to be followed by a significant move, or so the theory suggests. The direction of the breakout is not indicated by the Bollinger bands indicator though. A squeeze momentum strategy would use momentum as the means for gauging the direction. If you're interested in expanding the number of indicators you see in MT4, you should check out MetaTrader 4 Supreme Edition. It's a free plugin for MT4, with a selection of extra tools and indicators that have been chosen and developed by trading experts.
MT4 Momentum Indicator
As we have seen, the momentum indicator is a useful tool with a broad range of applications. The same tool can be used as a stock's momentum indicator and as a Forex momentum indicator. The versatility of the indicator also means that you can easily create momentum trading systems that work in the short-term as well as the long-term. As a general rule for the momentum indicator, the shorter the time-frame used, the more sensitive the performance will be. This comes with the catch that it is likely to generate more false signals compared with a longer time-frame.
Its broad applicability means that the momentum indicator could be the ideal tool for you, whether you're a day trader or position player. Of course, as we discussed in the first part of this article, the momentum indicator is not the only way of measuring the strength of the trend. There are plenty of other momentum indicators available in the market. So if you want to determine which is the best momentum indicator for day trading or long-term trading, what can you do? One thing you can do is to open a Demo trading account and test it out. This way you can decide for yourself which is the best momentum indicator in MT4. Rather than taking someone else's word for it, you'll know for sure what works best for you.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.