Best Momentum Indicator - Forex Trading Strategies

May 21, 2021 09:00 UTC
Reading time: 15 minutes

This article will provide you with insight into a Forex Momentum indicator in MetaTrader 4 (MT4) and MetaTrader 5 (MT5). We will demonstrate how to use the MT4 momentum indicator, share a momentum trading strategy and much more!


What is a Forex Momentum Indicator?

What is a Forex momentum indicator? What does it do? Before we understand what a momentum indicator is, we must first understand trends and momentum in trading.

One of the key concepts in technical analysis is the idea of a 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. So, how do you find momentum in forex or any other market? A Forex momentum indicator helps.

What is a momentum indicator? It is something that attempts to measure momentum. There are a number of such indicators.

Some of the better-known Forex momentum indicators are the Relative Strength Index (RSI), the Stochastic Oscillator and the Moving Average Convergence Divergence (MACD).

These are widely regarded as being some of the best Forex momentum indicators currently available. 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).

However, this article is going to focus on another oscillator that some argue is just as effective as its more famous counterparts. This is a Momentum indicator, which plots a curve that oscillates either side of a centreline value of 100.

Like the RSI and the Stochastic Oscillator, a Forex 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.

How to Use a Forex Momentum Indicator for Trading - Applying it to Your Chart

Now you know the answer to the question, 'What is a momentum indicator?". But, how do you use a momentum indicator for trading? It's time to look at the first step in learning how to use a momentum indicator for trading.

The Forex Momentum indicator comes as one of the standard packages of indicators available as part of the default versions of both MT4 and MT5.

Some traders call this one a momentum MT4 indicator.

The calculation behind it is actually fairly straightforward. It 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 default value for N on MetaTrader 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 momentum is then calculated as follows:

  • Momentum = (current close/close N periods ago) x 100

MT5 performs these calculations instantaneously and displays the results for you below your main price chart.

In order to add the Momentum indicator MT4 to your price chart, find "Momentum" under the Oscillator Indicators tab in the Navigator of MT5 (similarly located in MT4). Once found, click and drag it onto your current chart.

Source: Admiral Markets MetaTrader 5 - Momentum Indicator Settings

Depicted: Admiral Markets MetaTrader 5 - GBPUSD H1 Chart. Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

In the hourly GBPUSD chart above, you can see that the momentum indicator MT4 has been added and 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 MT5 does not mark the centreline of 100).

You can see that over the course of our chart, the 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 MT4 is one of several trend-gauging oscillators available by default with MT5. You also have access to RSI and Stochastic Oscillator.

There are other indicators that exist for measuring momentum, such as the Stochastic Momentum Index (SMI), however, these do not come as part of the default MetaTrader 5 platform and will, therefore, have to be downloaded separately if you are interested in using them.

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Using Momentum Forex Trading Strategies

The next step to learning how to use the MT4 momentum indicator in forex and other markets is its role in trading strategy. Let's look at some momentum forex trading strategies. You can learn how to 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 very rudimentary approach, however, and should be considered with great caution before implementing. 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 by adding a moving average.

Adding a Moving Average to Your Forex Momentum Trading Strategy

This is one of the most popular momentum forex trading strategies. Another step to consider when learning how to use a momentum indicator in Forex is how to use it with other indicators. 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 MT5's navigator, and then dragging and dropping it into your Forex 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: Admiral Markets MetaTrader 5 - Moving Average Settings

Depicted: Admiral Markets MetaTrader 5 - GBPUSD H1 Chart. Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

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 a Forex Momentum Indicator as a Confirmation Tool

This is also one of the most popular momentum forex trading strategies. Another key aspect of learning how to use a momentum indicator in Forex is using it to confirm trends. The indicator really comes into its own when used as a means of confirming signals from a separate, primary indicator.

One of the best methods is to look for divergence between price and momentum, as a way of measuring the strength behind a move. Your buy or sell signal would come from whatever you have chosen as your primary indicator. You would then seek to confirm the signal with the Forex Momentum technical indicator, by looking for whether the price/momentum divergence is either bullish or bearish.

Bullish divergence suggests an oversold market and can be identified if the price falls to new lows, but the Forex MT4 Momentum indicator fails to make new lows.

Bearish divergence, on the other hand, suggests an overbought market. This is identified when the price rises to new highs but momentum fails to make new highs.

You would only follow a buy signal from your primary indicator when this is confirmed by bullish divergence from your Forex Momentum technical 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.

Forex Momentum Indicator + Volatility Indicator: Squeeze

A further example of one of these momentum forex trading strategies is combining momentum with volatility measures to form a squeeze Forex momentum trading indicator.

Bollinger Bands provide a guide to volatility, widening in times of high volatility and narrowing when volatility is low. A Bollinger band squeeze Forex momentum indicator reveals a squeeze, which 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 indicator strategy would use momentum as the means for gauging the direction.

If you're interested in expanding the number of indicators you see in your trading platform, you should check out MetaTrader 5 Supreme Edition. It's a free plugin, for customers of Admiral Markets, with a selection of extra tools and indicators that have been chosen and developed by trading experts. Click the banner below to download today!

Using Forex Momentum Indicators in Swing Trading

Are there momentum forex trading strategies for swing trading? What about learning how to use a momentum indicator in Forex with swing trading? Swing trading is a trading strategy that traders use to try to profit from small price shifts within a larger trend. This works on the idea that price trends are rarely linear. Instead, there is tension between bears and bulls, which means it is constantly oscillating. Swing traders see such oscillations as an opportunity to profit.

By looking at the moments at which momentum switches direction, swing trading allows traders to profit across a shorter timeframe than traditional traders use. Similar to day trading, swing trading aims to earn a profit from both negative and positive price changes.

However, swing traders aren’t bound to the day trading practice of closing all positions before the day's end. Instead, they usually hold their trades for as long as the momentum lasts. This could be an hour, or even several days.

MACD for Swing Trading

One of the popular momentum forex trading strategies uses a specific indicator.

You know that learning how to use a momentum indicator in Forex with swing trading can be effective. So, how can we use a Forex momentum indicator in swing trading?

The MACD is one of the best momentum indicators for swing trading. This is a momentum indicator MT4 oscillator. This indicator is calculated by comparing two different moving averages, usually a short-term one and an intermediate-term one.

A commonly-used MACD subtracts the 26 EMA from the 12 EMA. 

As I have explained above, momentum precedes price. This is a key aspect of using momentum indicators in Forex trading. Basically, when a substantial amount of momentum develops in a market, the price will likely continue moving in the same direction. 

When using the MACD indicator, I look for convergence. I watch for the MACD to make a new high while the price is also making a new high, or vice versa. 

If the MACD isn’t printing a new momentum high while the market is breaking out, this usually means that the breakout won't be successful.

We can use the MACD as an indicator for trend-continuation, which will help us decide when to enter and exit swing trades.

For example, if there is significant momentum present in a market when it sets a new high, you'll want to watch for the price to come back a bit to enter. When it pulls back, you won't want to see the MACD set a new low. In ideal circumstances, the market will pull back under low volatility and volume without the MACD registering a new momentum low. 

Such circumstances indicate that the price may continue rising and the slight drop in price is not the start of a new trend, but may be an opportunity to enter a position with your swing trading strategy. In the same way, you can use the MACD Forex momentum indicator for swing trading to identify a shift in the price momentum back in the other direction, which may be an opportunity to exit your swing trade.

Final Thoughts

As we have seen, the Forex Momentum indicator is a useful tool with a broad range of applications. Traders can learn how to use one of the best momentum indicators in Forex and any other market to develop momentum Forex trading strategies and more. The versatility of the indicator means that you can easily create Forex momentum trading systems that work in the short-term as well as the long-term.

As a general rule, 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 MT4 Momentum indicator could be the ideal tool for you, whether you're looking for the best indicator as a day trader or position player. Of course, as we discussed in the first part of this article, this indicator is not the only way of measuring the strength of a trend.

Momentum forex trading strategies are only one aspect of the field of trading strategy. There are plenty of other similar indicators available in the market to help your trading.

So, you know how to use an MT4 momentum indicator in Forex. How can you determine which is the best momentum indicator for your trading style, or which is better for day trading or long-term trading?

One possibility is to open a FREE demo trading account and test it out. This way, you can decide for yourself which is the best for your needs.

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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.

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