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Rate of Change Paired with Momentum |
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Monday, 04 February 2008 |
Momentum and Rate of Change
A trader must know the time frame he or she wishes to use when calculating momentum. It is best when working with oscillators to keep the time frame duration short. This is because oscillators are best used to detect short term changes within a week's span, whereas trend indicators are best used for the longer term trend direction.
But how does momentum match up with the ROC indicators? Let's take a look at the two forumlae:
- ROC = (Today's closing price)/(Closing price "n" days ago)
- Momentum = (Today's closing price) - (Closing price "n" days ago)
The forumlae are very similar; ROC divides but Momentum subtracts.
Mathematics between the two
Naturally, if Today's closing price is higher than the price "n" days ago, we will have a positive value. We will have a negative value if Today's closing price is lower than the closing price "n" days ago, and we will have a zero value if the two variables are the same.
Likewise, the same holds true for the ROC; if Today's price is the same as the price "n" days ago, we have a value of 1, if Today's price is higher we have a value greater than 1, and if Today's price is lower than the closing price "n" days ago we have a value less than 1.
What this all means
The Trader can create a slope model of either Momentum or ROC based upon the values that are created from the above. This will thereby create a visual representation of whether Momentum or ROC is rising or falling.
When both rise to a peak, we can say the market is bullish. If they both fall to a new low, the market is bearish. We can also use the two slopes and compare them to the price trend to determine any divergences.
To conclude, we need to determine the difference between the two indicators aside from a mathematical explanation.
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If the ROC is an indication of the speed at which a shift in momentum is occurring, we can say it is an illustration of Trader optimism. When a Trader begins to speculate that an investment is bullish or bearish, they will begin placing their money into that security, thereby increasing the speed of momentum.
- Momentum is just a mathematical representation of the market shifting.
Therefore, using these two indicators together will not only help you to determine market shifts, but it will help you to determine the speed of the shift. The speed of the shift will help you to determine a momentum shift before it happens. This will help you to buy before a market rises, or sell before a market falls.
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