Regular readers are used to me discussing things about Hodo Global and RYZE.Ai and how you can make money trading currencies by utilizing them. In addition, I am now adding a series on basic trading tools for people who are interested in learning to trade on their own. The vast majority of people who venture out on their own to trade in the Forex market lose money. Alternatively, I would use a program like the RYZE.Ai artificial intelligence trading algorithm as a starting point and way to profit while learning the skills necessary to consider trading. In this vein, I have started with a basic concept, momentum.
What is momentum trading?
Momentum traders in the Forex market look for currency pairs moving significantly higher or lower on high volume and then jump on board to ride the momentum to a substantial profit. Forex traders who use momentum can hold their positions for a few minutes, or a few hours or throughout the day, depending on how quickly the currency pair moves and how soon the price changes direction. In a nutshell, momentum traders are looking to buy currency pairs where there is increasing volume and an increasing prices or conversely, to sell a currency pair where there is increasing volume and falling prices. So a combination of price movement and volume is needed. The theory here is that price moves are less significant when the volume is low and/or falling. For example, if you are looking at a 5 minute chart and the average volume over the past 12 periods is 1000 for simplicity’s sake and the price begins to rise but the volume falls to 800 and then 600 it would not be a good sign. It means that as the price is rising the buyers are disappearing, so the price rise will be hard to sustain or may reverse. Conversely, if the same price rise begins and the volume jumps to 1200 and then 1400 the rise is supported by many buyers and is probable to continue because more and more buyers are showing up to buy.
Most trading platforms like MetaTrader 4, the one I am using have a momentum indicator built in to the program. It will be one of the standard set included. The formula is simple, it is simply the closing price of the latest bar – the closing price of the bar x periods ago. In the example below I use a 12 period momentum parameter on an hourly chart so it would be the closing price – the closing price 12 bars (hours) ago.
I have captured a screenshot of a price chart of the hourly EURUSD currency pair (1 bar in chart is one hour) with a 12 period momentum indicator applied. I have highlighted a number of the buy points with red vertical lines. As you can see, the momentum indicator signals some potentially very profitable trade entry points.
Note: I did not optimize the momentum indicator to see which period length worked best with the EURUSD H1 chart, I just used the default setting of 12 periods. In the real world, let’s say I wanted to see if this would be a good way to trade. I would use a built in Strategy Tester and test this momentum indicator on this currency pair with all my parameters and see the results. I could then decide if this is a system I wanted to use in actual trading or use in conjunction with another indicator or time frame. For example, I could use this hourly chart to generate signals and also use the 15 minute EURUSD chart as a confirmation. We will talk more about testing in future posts, I just wanted to introduce the concept.
EURUSD H1 Chart with 12 Period Momentum Indicator
EURUSD H1 Chart with 12 Period Momentum Indicator with Volume
I have included another screenshot with the volume plotted as well. A moving average of the volume could also be useful to see if the volume is rising or falling. But this is useful because you can see the volumes typically rise to support sustained price moves and volume dissipating can portend a pause in the trend or a reversal.
Just like with moving averages recently, a lengthy dissertation could be written on the topic of momentum. This is intended to be an introductory level explanation. After I have introduced all the basic concepts, I may delve deeper into some of these topics in future posts.
If I have not been clear in my explanation or if you have any questions, please leave me a comment below or drop me an email to Xin@FXTradingIncome.com .
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A book I would suggest for people who would like to read more:
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