Our previous article on TrendlinesGlossary: A line drawn across a series of price highs or lows on a chart to show the direction prices have been moving. A clean break through it can signal the trend is changing. demonstrated a simple way to determine whether a given instrument is in an uptrendGlossary: An uptrend is a price that keeps making higher highs and higher lows over months; a downtrend is the reverse. A common test is whether the price is above or below its long-term moving average., downtrend, or consolidation. The ability to draw trendlines is extremely useful, but they identify a change in trend only after it has already taken place. The concept of momentumGlossary: The tendency of a price's recent trend to keep going, usually measured by its returns over the past several months. Positive momentum means it has been rising faster than its peers; negative momentum, falling faster. can warn of strength or weakness in a given instrument, often well ahead of the final turning point.
This article will examine the general principles of momentum interpretation and the rate-of-change indicator will be used to demonstrate this concept. Going back to high school physics class, the concept of momentum can be explained with this simple example. When a ball is thrown into the air, it begins its trajectory at a very fast pace. In other words, it exhibits strong momentum. The speed at which the ball continues to rise gradually diminishes until it finally comes to a very brief standstill. The force of gravity then causes the ball to reverse course and return to the ground. This slowing-down process is known as a loss of upward momentum. It is a phenomenon that is also frequently seen in financial markets. The price’s rate of advance begins to slow down noticeably before the ultimate peak in prices is reached.
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