Momentum analysis in your FX trading
As part of your routine of multiple-time-frame technical analysis, you should incorporate two technical studies into your regimen of analysis.
Factoring momentum analysis into your routine
The first study to include in your analysis is a momentum oscillator like RSI or stochastics. We also recommend Moving Average Convergence / Divergence (MACD) – it’s not technically a momentum indicator, but it certainly acts like one. In fact, we prefer MACD over the more traditional momentum studies because MACD tends to change direction and generate crossovers more slowly than the other momentum studies. The result is fewer false signals, but the trade-off is that the signal may be delayed, giving you a less advantageous price entry level. In reality, though, the generally slower MACD signals are well suited to the forex market’s tendency to push a directional move as far as it will go for as long as possible.
The second study that you include in your analysis routine is the Directional Movement Indicator (DMI) system. The DMI serves as a double-check on the momentum study. The Average Directional Index (ADX) component of the DMI is a trend identification signal that tells you whether the market is trending, regardless of direction. Relying solely on a momentum study can lead to serious problems when the market sets off on an extended trending movement.
Momentum studies typically register overbought and oversold readings after an extensive directional move, potentially signaling that the market is ripe for a correction in the opposite direction. Worse, shorter-term momentum studies routinely cross over as price movements inevitably slow in the course of a directional, potentially trending movement, giving a signal to trade in the opposite direction. But if a trend is, in fact, taking hold, those momentum readings can be highly misleading.
The key is to double-check momentum readings with the ADX level to see if trending conditions are in place. If the ADX is above 25, you should discount what the momentum studies are indicating. Don’t completely ignore what the momentum study is showing – just defer to the ADX reading while it’s above 25. when the ADX tops out and turns down, you have a second indicator signaling that the directional move is likely coming to an end. If the ADX is below 25, defer to what the momentum indicators are signaling.
Most charting system will allow you to save charts including multiple technical studies, such as MACD, RSI, stochastics, and ADX/DMI. Layer the studies to only one is visible at a time, leaving the maximum amount of space to display the price chart, which is always the primary focus. You can then toggle between different studies at your convenience.
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