You will often hear from Forex experts to always trade with the trend. It is easier said than done. First of all you will have to identify the trend early enough. Once you identify the trend, you will need to find its credibility. You should make sure that it is not a fake trend by judging its strength. This is where momentum indicator comes into play. There are plenty of them to help you. Some of the prominent indicators are CCI, RSI, and Stochastic.
Commodity Channel Index
It was originally designed for commodities and is used for other instruments as well to determine the trend, its most and least powerful period and reversals. There are many versions with many trading systems. It moves from +200 to -200. It is customary to buy when it goes above 100 as the up trend is confirmed. Opposite happens for -100. Zones beyond positive and negative 100 are considered overbought and oversold conditions. The zones beyond 200 are considered extremely overbought or oversold. In such cases you are supposed to dump your trades. When this momentum indicator crosses the zero line, appropriate trades like long or short should be taken and should be carried till the extremely overbought or oversold zones.
Relative Strength Index
This momentum indicator was developed by Welles Wilder and it takes into account the close of a candle over a specific period of time. A typical period is 14. Play with RSI is little different from CCI. Zones beyond 50 are considered as a confirmation of a trend up or down. Zone beyond 70 is considered overbought while that below 30 is considered oversold. Unlike CCI, you don’t buy or sell when a zone crosses above 70 or below 30. Once entered into these zones, price tends to stay there for a long time. So if you want to play with RSI, you sell when RSI comes below 70 from above and buy when it goes above 30 from below. Some Forex traders use the level of 50 instead of 70 and 30. It is also used with trend lines. When it is in accordance with the trend of RSI, then current trend is valid. If it diverges from the RSI trend, it is a signal to a possible reversal. Understanding how to use RSI trend lines is a competitive advantage because you come to know about it much earlier than with just RSI.
Developed by George Lane, this momentum indicator assumes that the price closes looks to close near its high or low when in uptrend or downtrend respectively. It value varies from 1 to 100 and has two lines- fast and slow lines. Levels 20 and 80 are important. Zone above 80 is overbought while that below 20 is oversold. Crossing a zone is considered a reversal or just a correction. There are many ways you can use this indicator. The simplest way is to sell when the fast line cuts the slow line from above and buy when it crosses the slow line from below. Next play is similar to RSI. You wait for the indicator to come below overbought zone of 80 and then sell and wait for stochastic indicator to come above oversold zone of 20 and buy. The last method is to use this momentum indicator for a divergence between the price of currency and the indicator. The divergence implies a correction so you can take appropriate trades.
Momentum indicator is a handy tool if used with some knowledge. Making money requires getting the edge with early identification of a trend or its reversal. These indicators offer you this edge so that you can be a profitable trader.