Momentum Study

By Samantha Baltodano

TL;DR:

The Momentum Study measures the speed at which a security’s price is moving in a certain direction. The goal with momentum trading is to "buy high, sell higher", instead of "buy low, sell high". 

What Is the Momentum Study?

The Momentum study measures the velocity of price changes over a fixed time period. In simpler terms, momentum is the rate of acceleration of a security's price—that is, the speed at which the price is changing. Momentum trading is a strategy that seeks to capitalize on momentum to enter a trend as it is picking up steam. 

Let’s put this into perspective.

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Think of it as the momentum of a train:

When a train starts up, as it accelerates, it moves very slowly. Once it gets up to speed, it stops accelerating but remains traveling at a higher velocity. 

At the end of the trip, the train decelerates as it slows down, but it can take many miles of track to apply the brakes on before finally coming to a complete stop. 

For the momentum investor, the best part of the train ride is in the middle, when the train is moving at its highest velocity.

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How to Interpret the Momentum Indicator

Investors can use momentum as a trading technique that seeks to profit off the herding behavior of market psychology. Rather than "buy low, sell high", momentum trading follows a strategy of "buy high, sell higher". 

Once a momentum trader sees acceleration in a stock's price, earnings or revenues, the trader will often take a long or short position in the stock in the hope that its momentum will continue in either an upward or downward direction. This strategy relies on short-term movements in a stock's price rather than fundamental value.

The momentum indicator is often analyzed based on its crossovers with the zero level. Crossing above the zero line and further rising may signify upward acceleration while reversal to zero could mean that the trend is decelerating. 

Conversely, momentum values falling below zero might be regarded as a sign of downtrend emergence, with the downtrend getting stronger as the indicator values continue to drop. 

Calculation

By default, the momentum is calculated as the difference between the latest close price and the close price 12 bars prior to it. Both the price type and the offset period are customizable.

Summary

• Momentum, finance, refers to the capacity for a price trend to sustain itself going forward.
• Strong momentum can continue in an upward or downward trend, which can be confirmed by changes in trading volume and other technical indicators.
• Momentum investing is a trading strategy in which investors buy securities that are rising and sell them when they look to have peaked.
• Momentum trading therefore describes a herding strategy, following others; but price trends are never guaranteed in the future.

Momentum is just one of many studies that Archaide automates. For a full list of strategies and studies available click here.

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