Background: It isn’t enough to analyze markets when you only look at one static price. Is that price high or low? Does that one price suggest a series of prices that are moving higher or lower? Traders have long looked at charts to get a visual picture of how prices change over a period of time – how today’s price relates to the price at some point in the past.

Purpose: The momentum indicator is a simple way to measure the velocity of price change instead of looking only at the price levels. The formula is rather basic: Subtract the closing price 10 days ago (or some other time interval) from the current closing price. This value will be either positive or negative. Plot these numbers around a zero or neutral line. A positive value for momentum would be placed above the zero line, a negative value below the zero line.

Basic signals: The series of momentum values will produce a line that indicates whether prices are rising or falling over the period of time analyzed. When the momentum indicator moves above the zero line, it suggests a rising market and a buy signal; when the momentum indicator falls below the zero line, it suggests a declining market and a sell signal.

Of course, these crossovers should not be viewed as absolute reasons for taking a trading position but should be considered in light of traditional chart patterns and other market factors.

In some ways, the momentum indicator looks like a moving average, but perhaps the biggest value of the MOM indicator is that it serves as a leading indicator of accelerating or decelerating price change while moving averages are a lagging indicator. As the chart below illustrates, the MOM indicator started to fade before the price trends did as prices started to lose momentum.

Also, like other indicators, MOM also provides clues on direction when it diverges from price – prices make higher highs while MOM makes lower highs, in this case, suggesting an upcoming downtrend.

Pros/cons: Monitoring the MOM indicator provides an excellent way to get an edge on price movement ahead as changes in the difference of prices will occur before the effect is likely to be noticed on a chart. Like other indicators, MOM is not a stand-alone means for determining price direction but is a tool that can provide and early alert about prices when used with chart patterns and other indicators.

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