Moving Average (MA), are techniques which are extremely useful, but they identify a change in trend only after it has taken place. The use of momentum indicators can warn of latent strengths or weaknesses in the indicator or price being monitored, often well ahead of the final turning point.
The Concept of upside momentum is illustrated in the following example the following diagram shows this:
When a ball is thrown into the air, it begins it’s trajectory at a very first place; i.e. it possesses strong momentum. The speed at which the ball rises gradually diminishes, until it finally comes to a temporary standstill.
This slowing-down process, known as a loss of upward momentum, is a phenomenon is also experienced in financial markets. The flight of a ball can be equated to a market price. The price’s rate of advance begins to slow down noticeably before the ultimate peak in prices is reached.
One of the main momentum indicators used is RSI.
The Relative Strength Index or RSI was developed by Wells Wilder. It's a momentum indicator, or oscillator, that measures the relative internal strength of a stock or market against itself, instead of comparing one asset with another, or a stock with a market.
The formula for the RSI is as follows:
Where RS = The Average of x days up closes divided by the average of x day's down closes. The indicator's design aims to overcome two problems involved in construction of a momentum indicator:
• Erratic Movements
• The band for a constant trading band for comparison purposes.