5 Best Momentum Indicators of 2023
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Stock charting apps and trading platforms allow you to apply momentum indicators on a chart. But what are the best momentum indicators, and how beneficial are those to identify momentum and market trends? We have reviewed the most popular momentum indicators, and here are our top 5.
What is momentum trading?
Momentum trading is a technique frequently used by short-term investors looking for fast price changes within a short time to get in and out with a profit quickly. Stocks often trade with high momentum after company news (e.g., earnings) and go along with high trading volume (relative number of shares traded). Momentum indicators help to identify the high momentum.
Best Momentum Indicator – Top 5
1. Relative Strength Index (RSI)
The Relative Strength Index (RSI) is a trading indicator implemented in nearly all trading tools. From free stock charting websites to professional stock analysis tools, all have it integrated due to its immense popularity in the trading community.
The calculation method of the RSI is relatively simple. It can be done by dividing the average number of higher closing prices over a specific time by the average number of lower closing prices. So if you use the most popular setting, the RSI 14, it compares the higher and lower closing prices of the past 14 periods to each other.
The plotted results range from 0, the lowest point, to 100, the highest measured point, where everything in the lower third is an oversold condition and an overbought condition in the upper third.
Besides using the RSI for indications just based on the oscillating price, you can also use it to spot divergence. If, for example, a stock makes new highs, but the indicator does not, then there is a divergence between the strength of the stock price and trailing strength via RSI.
2. Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence indicator is great for spotting momentum. The indicator consists of a MACD line (n-period EMA – n-period EMA), a Signal-line (n-period EMA of MACD line) and the MACD histogram (MACD line value – Signal line value)
Basically, the MACD compares a longer-term n-period exponential moving average to a shorter-term n-period EMA. N-period reflects the number of time increments included in the calculation. When using a daily chart, the n-period is the number of days. If you are on a 5-minute chart, n-period is the number of 5-minute increments to be included in the calculation.
Evaluating the MACD values manually doesn’t make sense since the calculation is too complicated. Therefore it is reasonable to use a good analysis tool for that purpose.
The MACD is typically interpreted in the way that when the signal line crosses the 0-line, the momentum finally shifts. Some also use higher highs and higher lows of the signal line to identify a divergence between the price readings on the chart vs. the MACD value.
The best is to use backtesting software to evaluate what settings work best.
3. Average Directional Index (ADX)
Welles Wilder’s ADX momentum indicator value calculation is even more complex, considering the periods high, previous high, currently low, average true range, smoothed values of those variables etc. So, it is not reasonable to manually calculate the values, even if the basic concept is relatively simple, where the price range of the current and previous periods are measured and smoothed.
All popular trading platforms have this indicator integrated, and it is also one of the most frequently used day trading Indicators. Maybe not as popular as VWAP, Fibonacci retracements and the MACD, butt yet effective when appropriately used in trending markets.
The reading of the ADX is that when the ADX rises, the price momentum increases. In contrast, if the average directional index value trends lower, the momentum goes lower. The ADX only indicates momentum strength. That means that a high momentum reading can mean a high momentum in the market to the upside or downside.
4. Stochastic Oscillator
George Lane developed the Stochastic Oscillator back in the 1950s, and is used by traders to evaluate potential overbought but also oversold conditions in the financial markets. The momentum indicator is so popular that nearly all trading tools you use for analysis have it, even your broker-integrated platform.
The Stochastic Oscillator compares the closing price of an asset to the defined highs and lows over a certain period of time. With an oversold level near the zero line and an overbought level near the 100-oscillator line, traders typically use the Stochastic Indicator to spot price reversals in the underlying asset.
5. Commodity Channel Index (CCI)
The CCI indicator was one of the first ones I’ve ever experimented with, but the variations of signals held me back from continuing to use it. Yet, it is a momentum indicator, and especially the internet trading community hypes the CCI a lot. That’s why it is on the list of the best momentum indicators.
So, how do you read the CCI? The CCI is typically used to determine a trend and part of technical analysis methods, where a CCI moving through the upper +100 band indicates a newly establishing uptrend, and a break through the lower -100 band indicates a strong downtrend is beginning. Therefore, CCI traders are often flat between -100 and +100 but go long above +100 and short below -100 while exiting the trade once the indicator falls back to the band again.
Overall, the technical indicator measures the difference between the current price vs. its historical average price. Once the CCI goes above 0, it already implies that the current price is above the average, but the real bullish scenario only unfolds above +100, and vice versa for the bearish scenario.
Donald Lambert developed this indicator, but while CCI reads simple, it’s difficult to evaluate manually since you compare multiple periods high, low and close, consider a certain number of periods, moving average values and a mean deviation. So, all in all, much too complicated to calculate on your own.
Best Momentum Indicator Conclusion
The best momentum indicators are found in the list of the best forex indicators, but also crypto indicators since they work on all types of assets. Day traders frequently use this indicator because they focus on high-volatile markets that move on high momentum to one or the other direction and want to avoid slow-dows and side-ways wipeouts.
To apply a momentum indicator on a chart, open your paper trading platform or stock market simulator that you want to use for risk-free testing and open a chart. Personally, I use the candlestick chart type to spot candlestick patterns alongside indicator-identified momentum setups, but it also works with bar charts or line charts. The visualization will typically be in a separate row below the price chart since a chart overlay is not helpful.