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Trading with Momentum Indicators

Trading Momentum
Written by Andy

When you decide you want to make money trading contracts for difference, you will need to look into a trading education, whether by reading or by other courses of study. One of the most worthwhile ways that you can improve your trading performance is by learning about all the technical indicators that have been invented by generations of traders to generate anticipation of the future by manipulating the past results.

Technical analysis is the art and science that enables traders to improve their expectation of profits, and it is continually evolving. Some of the indicators are called momentum indicators, as they work by considering the momentum behind the price movements on the chart, to attempt to detect the mood and sympathy of the market participants.

This type of momentum is not to be confused with the momentum which is exploited in a trend trading system. That momentum simply states that a trend will continue unless something happens to change it. No, momentum indicators use the chart information and perform calculations to generate other numbers that can be interpreted to assist in the trading selections.

One of the well known momentum indicators is the RSI, the Relative Strength Indicator or Index. This combines facts about the strength of the price movement of a security to produce a number that is typically represented on a scale of zero to 100%. It combines the average up move with the average down move over a settable period, by default often 14 days, to get a percentage.

If the percentage is over 70% to 75%, then the security is considered overbought, and likely to decline. In such a situation, you might decide to take a short position with CFDs to multiply the effectiveness of your trade by the gearing provided by the derivative. If at the other end of the range, the security may be a bargain, and if other signs confirm this you can trade long using CFDs for maximum impact.

Note that sometimes we talk about relative strength when discussing market sectors or indices. That is a different relative strength to the RSI, which just considers the stocks strength in comparison to itself.

Another momentum indicator is the Stochastic. Again we can be grateful for computers that allow us to easily calculate and get the figures to use in trading. The basis of this indicator is that the closing value is compared to the range of values traded over a period, and the concept is that in an uptrend, the closing value tends to be in the upper part of the trading range. Dr George Lane, who invented this, was experimenting with many other techniques at the time which he labelled alphabetically, so this has become known by its investigational letter of K. The computer generates two lines, called the %K and the %D, which latter is actually just a moving average of %K.

In use, the Stochastic can provide overbought and oversold indications, just like the RSI. Some traders also take the line crossover as a signal. For either of these momentum indicators, if the indicator is moving in the opposite direction to the price, that is a warning of changes to come.

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