Momentum (part one)

In forex markets, the Momentum indicator detects if and how strongly the price of a currency pair is moving upward or downward. More precisely, it measures the rate of change in prices compared to the actual price changes themselves. The indicator is measured by calculating price differences over a given time period. For example, to create a 5-day period momentum line, a trader should subtract the price from 5 days ago from the most recent price.

The Momentum indicator detects where the current price is in relation to where it was in the past. The calculated differences are then plotted around a zero line. If the current price is higher than the past price, then the indicator is positive; this means that the price is moving upward. Otherwise it is negative; this means that the price is moving downward. The indicator is unbounded, as it does not have an upper and lower boundary. This is why a trader must visually inspect the momentum line and draw horizontal lines along its upper and lower boundaries. When the momentum line hits these levels it indicates that the currency pair may be overbought or oversold.

Since Momentum is an unbound oscillator, the interpretation of whether a currency pair is overbought or oversold is completely subjective and depends on the opinions of single traders. When the indicator is overbought, the price continues to move higher. When it is oversold, it continues to move lower. The indicator is often used in conjunction with other technical indicators, in the attempt to identify overbought or oversold prices. A crossing above (below) the zero line during an uptrend (downtrend) may be interpreted as a buy (sell) signal. When using these signals, a trader should always trade in the direction of the overall trend.

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