A momentum indicator is a factor that aids in assessing the rate of change experienced by a given asset within the marketplace. As the name implies, the focus is on how quickly the price of that asset is progressing in the market, and how soon an investor can anticipate reaching a specific level of return on that investment. There are a number of ways to assess the momentum indicator, with comparing the most recent closing price for the security with a closing price that occurred recently being one of the most common.
In order to properly assess a momentum indicator, it is important to take into consideration past history as well as the current status of the security’s price. The idea is to evaluate historical trends and identify periods in the past when similar market conditions prevailed. This in turn makes it easier to understand how the security price moved up or down in response to those conditions, and use that information to forecast the momentum that the security will enjoy in the near future.
If the projection that is developed using the momentum indicator proves to be accurate, then the investor is able to use the indicator to get an idea of how long it would take for the security to generate a specific amount of return. This is important, since the investor may have very specific ideas about how much he or she wants to profit from the investment in order to make it a viable purchase. If the momentum indicator indicates that the trend will reverse before that desired return is reached, the investor may choose to hold the security for a time, then sell it at a smaller profit and use the funds to purchase a different investment that shows greater promise of earning the desired return.
While a momentum indicator is often associated with the speed of forward movement, it can also be used as tool to gauge the rapidity and duration of the backward movement of a given stock option. Here, the goal is to assess market trends and take historical data into account to determine when the price of a given stock will reach the lowest level, then begin to climb once more. Accurately projecting this type of negative momentum makes it possible for an investor to buy shares just as the stock reaches its lowest point, then enjoy the returns generated when the trend reverses and the stock begins to increase in value once more.