How to Use a Momentum Indicator in Forex Trading

The momentum indicator is pretty self-explanatory by definition. It is a tool to determine the momentum that a financial instrument has when it is falling or rising in the exchange rate. However, when we ask the question “how to use the momentum indicator” usually the answer is to only activate it when the market is growing.
Very rarely do we see the momentum indicator used for declining markets, as people don’t really try to generate payouts off of their preferred currency pairs when they lose ground. However, when it comes to stocks, most investors would use the momentum indicator to see how much potential the fall has to continue into the future.
Furthermore, it’s believed that markets tend to rise much more often than fall, hence the more active use during bullish sentiments rather than bearish.
In this momentum indicator tutorial, you will learn how to calculate the momentum of the market, how the formula works, and what you can use the information you gain from this indicator for.
We will go into quite a lot of detail in order to make sure that everything about the indicator is covered, including the installation process as well as the use cases of the tool.

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Momentum indicator calculation - how to do it

Imagine that the USD/JPY currency just jumped significantly because of some kind of market news or a random spike during peak hours of trading. Most people would see this as a perfect opportunity to enter the market, but the issue here would be that there is no reasonable belief on whether the uptrend will continue or fall flat within a couple of hours or days.
This is where the momentum indicator shines in all of its usefulness. The lines displayed on the chart would signal the traders whether or not the momentum of a specific asset’s growth is positive or negative. If the momentum indicator Forex shows that the market sentiment is positive, it is very likely for the currency pair to continue rising in price for at least the same trading session.
How to use momentum indicator
However, much like everything else in Forex trading, there is always something that cannot be predicted that could hinder the progression of momentum. This is what people call a momentum fluke, as the market suddenly changes its direction with the indicator not having enough time to react.
In order to avoid being a “victim” of this abrupt stop, most people conduct momentum calculations on their own. The calculation is quite simple compared to other tools as it comes with a momentum indicator formula, which is the following: “Z = X - Xy
  • Z is the momentum
  • X is the latest price of an instrument
  • Xy is the price of an instrument y days ago
The most common numbers you will find with this indicator are 4, 7 and 21, which are usually representations of trading days. 4 represents the current trading session, 7 represents the trading sessions including weekend stagnations and 21 represents the monthly progress.

Mistakes to avoid when using the momentum indicator

One thing that needs to be considered when using this tool is that it’s not magical and doesn’t guarantee a 100% success rate. It’s something that needs to be taken into account with other tools as well. Here we will list a few mistakes that a momentum indicator strategy should avoid for it to be a bit more effective.
Momentum indicator Forex

Mistake 1 - using the momentum indicator alone

As already mentioned above, a momentum indicator is a background tool. It does not give very specific signals on where it is best to enter the market. For example, imagine that the indicator is showing that there is very high momentum with the USD/JPY tool, it does not, however, show which price point is good to enter in order to avoid as much risk as possible. That role falls onto the Pivot Points that could be a very useful tool alongside the momentum indicator.

Mistake 2 - blindly trusting the momentum meter Forex indicator

Another mistake that has been observed among beginner traders is that they trust the momentum indicator too much. Although it is a very good and useful tool, its use should always be moderate. For example, imagine that the price of a currency pair has just jumped significantly and the momentum indicators are showing positive results. However, you decide to check the news or look at your volume indicator to make sure that this is something that’s sustainable.
Soon you find out that the growth was based on news that market changes will be happening for 1 day and the volume is significantly lower than the momentum itself. Even the best momentum indicator would not show these metrics, therefore blindly trusting only one tool may not be the best of ideas.

Mistake 3 - using the indicator on a declining market

Although the momentum indicator has its uses during a declining market as it can show the momentum of the fall as well, it’s definitely not as effective as using it on a rising market. There are not too many traders that go short on a high-momentum price drop simply because it always has an abrupt stop. And it’s quite common knowledge that FX markets tend to correct themselves after a fall quite quickly. Therefore there’s always the risk of having an abrupt stop to the momentum and a quick rebound of the market on a shorting position. All in all, the momentum indicator MT4 would not be as useful on a declining market as it would be on a rising one.

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Momentum indicator tutorial - Key takeaways

The momentum indicator is one of the most useful tools that a trader can have in his arsenal, however, it’s not as “strong” as other indicators such as volume or Pivot Points. It does not give clear and concise signals on when and where it’ best to enter the market. It simply supplies the trader with information that then needs to be analyzed further in order to make the best decision.
The most common “decisions” on this would be, positive momentum = enter market, negative momentum = close trades.
One of the best momentum indicator Forex traders usually use comes with an in-built volume indicator as well. The reason is that these two tools are very useful when combined together. The momentum indicator provides the information that there is either a positive or negative shift, and the volume indicator helps the trader understand whether or not that momentum is justified.
For example, if the volume shows that there is more demand than supply, then the positive momentum is justified, and placing a trade could be a good idea. However, if the supply is higher than demand, but momentum keeps showing positive, it may be best to wait a little bit for everything to correct itself.
The tool is not something that can be used alone. It simply shows what the market is going through, rather than directly telling the trader what’s the best course of action.

FAQ on momentum indicator Forex

How do I install the momentum indicator?

It is very unlikely that you will have to download or install the momentum indicator. The MT4 platform, as well as MT5 and cTrader, come with this tool pre-installed by default. However, if for some reason your software is missing this feature, the most reliable way to install it is to download from either the MetaQuotes marketplace or the cTrader website, depending on which software you are using.
Once you have downloaded the tool, simply find the file and follow these steps:
  1. Locate your trading software folder
  2. Copy and paste the momentum indicator file into your indicators folder
  3. Restart your trading software
  4. Find the indicator in the Indicators > Oscillators

Why should I use the momentum indicator?

The momentum indicator helps to better understand upcoming and past trends. The art of how to trade with the momentum indicator mostly lies in the understanding of the market itself. Once the trader figures out how the market works, the momentum indicator becomes a “double-check” tool rather than a primary tool. All in all this indicator has the potential to teach new traders the intricacies of the FX market to its core.

Should I use the momentum indicator for FX or stocks trading?

There is no clear answer for this, but considering the volatility and the things that affect each of these markets, most traders would say that the momentum indicator is designed for FX trading more than stock trading.
The reason being is that stocks are relatively easier to predict with news and analysis of its own for individual companies, while Forex pairs are slightly more unpredictable. All in all the top momentum indicator for FX trading is indeed made for FX, but can be used for stocks as well.

How to read momentum indicator?

The momentum indicator, also known as the Forex momentum meter, is a research tool that helps you determine the strength or weakness of the price movement of a specific currency pair. It introduces a whole new insight into the asset conditions in a market, which can usually prove beneficial to your successful trading endeavor. With this indicator momentum of an asset price is represented within the Relative Strength Index (RSI): you take a scale from 0 to 100, and check the price movement against it. If the score is lower than 30 (or 20), it's considered oversold and its price might start rising, whereas the scores above 70 (or 80) are considered overbought and they might start declining. The RSI score can be calculated within the MetaTrader momentum indicator, as well as in any other trading software. 
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