The two most widely used momentum indicators amongst professional and retail traders are the RSI and the CCI indicators.
The momentum indicator is designed to recognize the strength of price movements by identifying and plotting the rate of change. It is displayed in its own chart usually under a price chart for comparison, and is displayed as a single line.
Momentum Indicators:
There are several popular momentum indicators which are used by both retail and professional traders. The two most widely used by both professional and retail traders are explained below.
Commodity Channel Index:
The most popular momentum indicator is the Commodity Channel Index. New traders tend to avoid using the CCI and it isn’t an element of their learning curve. However, as they become more proficient traders they usually find out about the straightforwardness of the indicator. The CCI is best used for longer time frames such a daily, weekly and monthly.
Most experts advise that the CCI should be used for entries and exits when the CCI has reached either +100 or -100. If the CCI moves above +100 it is indicating a confirmed strong upward trend, so therefore traders should go long. The trade is held open while the CCI is holding above +100 and exited as soon as CCI falls below -100. The exact opposite is true for downtrends where the CCI is below -100.
Relative Strength Indicator:
The Relative Strength Indicator is another popular and easy momentum indicator to interpret. As with the CCI the best results or readings are for the longer time frames (daily, weekly and monthly). This indicator is often described as an overbought/oversold momentum indicator which if interpreted correctly helps identify entry and exit timings.
The interpretation of the readings is that when the RSI reads above 70 the market is overbought whilst if the reading is below 30 the market is oversold. Since the RSI may stay in the overbought for quite a while being above 70 is not a sell signal. The same is true for readings below 30.
A true buy or sell signal occurs when the RSI crosses down from 70 (sell signal) or when it crosses up from 30 (a buy signal). In other words buy and sell signals occur when the RSI leaves the overbought or oversold areas.
How to interpret a momentum indicator and apply the data for a possible trade?
The forex chart below is a NZD/USD daily price chart which shows that on the 17th March 2011 the RSI was below the 30 reading and in an oversold area. A trader reading this signal would reason that once the RSO crossed back above the 30 (circled blue line) it would be a buy signal. On seeing this happen the trader could have bought NZD/USD at around 0.7117. The trader could then wait until the RSI crossed down from 70 reading (circled red line) from the overbought area and sold NZD/USD at 0.8059.
Such a trading strategy would have gained the trader over 900 pips.
In conclusion both the CCI and the RSI are useful popular momentum indicators which are simple to interpret and if used correctly can bring a trader nice profits.
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