Trade with the trend is the most commonly told mantra by the experienced traders. It is easier said than done. First of all you will have to identify the trend early enough. Once you identify the trend, you will need to find its credibility. You should make sure that it is not a fake trend by judging its strength. This is where momentum indicator comes into play. Many such tools are available to perform that task. Most commonly used indicators are CCI, RSI, and Stochastic.
A Simplest Indicator
Intended to use for commodities, now it is used with many financial instruments to spot the trend, its strength and a possible turnaround. There are many versions with many trading systems. It moves from +200 to -200. When above 100, uptrend is held and you can buy. Opposite happens for -100. Levels on either side of 100 are considered overbought and oversold. Extremely overbought and oversold zones sit beyond 200. When it enters in this territory, you are expected to close the trade. When this momentum indicator crosses the zero line, appropriate trades like long or short should be taken and should be carried till the extremely overbought or oversold zones.
Relative Strength Index
This momentum indicator was developed by Welles Wilder and it takes into account the close of a candle over a specific period of time. By default the period is 14. Play with RSI is little different from CCI. Up or down trend is confirmed when it crosses the levels beyond 50. Zone beyond 70 is considered overbought while that below 30 is considered oversold. As opposed to CCI, when levels are broken above 70 or below 30 instead of taking trade, you wait. Price spends lot of time in the overbought and oversold conditions. So if you want to play with RSI, you sell when RSI comes below 70 from above and buy when it goes above 30 from below. A level of 50 is used by many traders. It is also used with trend lines. When it is in accordance with the trend of RSI, then current trend is valid. If it diverges from the RSI trend, it is a signal to a possible reversal. If you can use RSI with trend lines, you have an edge over many traders.
Use Trend Line of Stochastic for Edge
Developed by George Lane, this momentum indicator assumes that the price closes looks to close near its high or low when in uptrend or downtrend respectively. It value varies from 1 to 100 and has two lines- fast and slow lines. Zones below 20 and above 80 are critical. They are called overbought and oversold respectively. Crossing a zone is considered a reversal or just a correction. There are many ways you can use this indicator. The simplest way is to sell when the fast line cuts the slow line from above and buy when it crosses the slow line from below. Next play is similar to RSI. You wait for the indicator to come below overbought zone of 80 and then sell and wait for stochastic indicator to come above oversold zone of 20 and buy. The last method is to use this momentum indicator for a divergence between the price of currency and the indicator. Divergence is construed as correction indicating you an appropriate trade.
If used intelligently, momentum indicator can improve your success rate in trading. You will have to spot the trend well before the masses so that you can make money with lesser risks. The weapons of indicators give you a competitive advantage over others.