4.3 Using Momentum Indicators to Confirm the Trend

Momentum indicators are lagging indicators which are good at spotting trends once they are in place. So the chances are that a portion of the trend has already escaped our clutches! But we won’t crib, because we know that the laggards are late but mostly correct. So we are saved from many fake-out trades that play havoc with our pip wealth. The downside is that many times the signals come so late that a reversal may already be around the corner.
Examples of momentum indicators are the Moving Average Convergence Divergence (MACD) and the Moving Averages (SMA, WMA  & EMA) indicators.
Now let’s check out the momentum indicators with an example.
Lagging indicators or momentum indicators on a Forex chart . 
In the above Forex chart, on the left hand side, we can see the MACD bearish crossover. During the same time the 5-period EMA bent down to almost move below the slower 22-period EMA. MACD crossover did not sustain and was followed by a bearish crossover. The fast EMA also moved up bullishly. It was surely a dream long trade. 
The second signals given by these momentum indicators are on the right hand side of the chart. We see the situation in reverse – a MACD crossover to the downside, followed a little later by the Moving Average crossover. The price duly plunged, but due to the delayed signal from the Moving Average, we would only have cashed half the down move.
If we analyze all these three signals we will have the following observations.
  • The first bearish signal came so late because of the lagging factor that the any trade based on MACD crossover would have ended to be a bad trade.
  • The second bullish signal was a great one and you would not have been affected by the lagging factor as the upward momentum was slow.
  • The third bearish signal by moving average had a big lagging factor and though it was safe but we lost half the move. MACD signal did not lag much because the first red candle was quite big and MACD immediately moved down with that.
Out of three signals we lucked out with the two even though at times trades entered might be late but based on safe signals from the lagging indicators. But here’s a situation where things could have gone just a bit wrong. Let's have look on the following chart with the same momentum indicators:
Momentum indicator giving false signals. 
Check out the MACD crossovers signaling "sell" on left and right side. And see how in both cases the Moving Averages did not cross over and confirm. A short-selling order entered on the basis of the MACD signals would not have been profitable. 

But we do not say that you need to use two momentum indicators to confirm each other. That may become messy. What you need to realize that no indicator would go right all the time. False signals will be bound to come up. What you need to do is to look for any other signs to confirm a signal. These could be resistances and supports, whether stationary or dynamic or candlestick patterns or divergences, as we will explain later. In the above case the 22-period moving average was acting as support during the bearish crossovers. In fact some traders run combinations of a leading oscillator and laggard momentum indicator. 


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