Market Momentum is the acceleration rate of the price of the security or market. Or, we can say, it is the ability of a security or market to sustain the rise or drop in prices. Market momentum is inferred and has a direct relationship with the trading volume. Hence, momentum gets generated when there is a substantial trading volume in a particular stock or in the overall market during a specific time period. This means when the trading volume is more, it accelerates the market momentum of a price change and vice versa.
For instance, if the S&P 500 Index goes up by 200 points in a day due to heavy trading, the index is likely to sustain this trend in the days ahead.
Market Momentum Equation
Though the market momentum is more of sentiment, we can define it using an equation:
M= Market Momentum; V= the spot or latest price of the security or index; and Vx=the latest closing price x number of days earlier.
One can use this equation to create a trendline with different periods on the charts for a better understanding of the momentum.
More About Market Momentum
In simple words, we can also say that momentum is the pace of movement in the stock price. As we know, speed or the pace of movement is an important indicator or reflection of the stock behavior. Its concept is based on the observation that the stock with robust momentum (good trading volume) in either direction is more likely to continue in that direction. This will also give us an indication of the general trend in the stock or market. Usually, hot stocks continue to move in one direction for a considerable time. Even if there is no further news to support the movement, such a feature could prove extremely crucial for investors when creating an investing strategy. Similarly, sometimes we see despite good news or better results, the stock prices continue to slide. This momentum helps us to predict this or understand the reason for such behavior.
Like with many other stock market concepts, the concept of momentum also depends on investor psychology. If a share continues to rise, it would automatically attract new investors hoping to make money from the stock. The concept of head mentality and fear of missing outplays extremely well in rising markets.
Due to this important feature of indicating trending and speed of the trend, the market momentum is a critical and important ingredient of technical analysis. A proper study of the momentum can give us an idea about the direction of the market movement. Moreover, there are many momentum indicators (RSI, stochastics, and more) that technical analysts can use to get an idea of the price change market trend.
Market Momentum Indicators
A trader can get a rough idea of the momentum by just looking at the price data. However, traders can get a better idea of the momentum and securities to buy/sell by using momentum indicators.
But like with other indicators, investors must not solely depend on these indicators. Instead, they must use these tools to back their market or stock expectations. And the decision should be taken considering other parameters and indicators also.
Oscillators are the most popular indicator of a stock’s momentum. Basically, an oscillator could be any indicator that is bounded by any fixed scale. It gives an idea of when a particular momentum is losing steam. Primarily, there are two types of oscillators.
The first ones are those that fluctuate between two fixed extremes – high and low (say between 0 to 100). And another one that fluctuates around the baseline, and the baseline number remain zero.
We will discuss below the two most popular Oscillators:
MACD (Moving Average Convergence Divergence) is a centered oscillator. An oscillator that moves around the baseline. The baseline value of the MACD is 0. It basically calculates the difference between the 12- and 26-day exponential moving averages of a share. Apart from the MACD line in this oscillator, there remains one more line that is the “Signal Line.” That signal line is a 9-day EMA of MACD. A trader looks at these two lines together to identify the momentum.
The MACD suggests a bullish sign if the MACD line goes above the EMA. And, when the MACD line drops below the EMA, it indicates a bearish scenario. If the two lines move in the opposite direction or are very far from each other, it suggests that the trend is over.
The positioning of the MACD is crucial as well. It means that if the MACD line is positive, it signals an upward trend, and if the line is negative, it means a negative trend.
Relative Strength Index
Relative Strength Index (RSI) is not as complex as MACD, yet it is as popular as MACD. This oscillator basically measures the gap between the recent relative gains and losses of a stock or security.
Unlike the MACD, the RSI is a banded oscillator as its maximum, and minimum value is 100 and 0, respectively. So, when the RSI is closer to these extreme numbers, it is a signal of momentum getting finite or reaching its extremes. In the case of RSI, the general opinion is that the RSI is understood to be in an overbought zone if it crosses 70. Similarly, it is understood to be in the oversold zone if it dips below 30.
Market Momentum Indexes
Apart from the oscillators, traders can also use Market Momentum Indexes as an indicator of momentum. Two firms that have come up with such indexes are MSCI and FTSE Russell. Some of the most popular indexes are the MSCI USA Momentum Index, the MSCI World Index, the Russell 1000 Momentum Focused Factor Index, SPDR Russell 1000 Momentum Focus ETF, etc. These indexes primarily use a momentum score.
Apart from the MACD, the RSI, and indexes, there are many more momentum indicators. However, most of the other indicators work on the same premise as these three indicators. Some of these indicators are: Moving averages (MA), Volume weighted average price (VWAP), Positive and Negative Volume Indexes (PVI and NVI), Average Directional Index (ADX), and more.
How to Use?
A positive momentum could signal a possible bullish trend, and a negative momentum could signal a bearish trend. Momentum could be for asset classes, as well as for individual securities. The market momentum, in general, refers to the overall market.
The use of momentum for trading is called momentum trading. In such a strategy, a trader aims to take a position when a trend is picking up. For instance, more corporate reporting profits can result in positive price momentum. And, in fixed income securities, dropping interest rates could lead to price momentum.
Overall, in momentum trading, a trader benefits from the herd behavior of the investors. Unlike the usual “buy low, sell high” strategy, in momentum trading, traders “buy high, sell higher.”
So, when a trader witnesses acceleration in the share price, then they will usually take a long or short position expecting the momentum to continue. It will not be wrong to say that such a strategy depends mainly on the short-term movement in the share price and not fundamentals. Usually, traders deploy a 10-day time frame for calculating the momentum.
In the case of individual securities, the momentum can be because of many factors, such as revenue, earnings, and more. Moreover, momentum can also be due to reducing the company’s debt.
Market Momentum is a crucial concept in the world of finance and mainly for traded stocks, securities, currency, and assets. Traders can use it to time their positions to make short-term gains. Moreover, it is a useful technical analysis tool that traders can use in combination with other tools to make more informed decisions.