Momentum gets talked about a lot in the markets. In physics, momentum is the rate at which an object changes speed. In markets, momentum is the rate at which price increases or decreases. But how do we quantify momentum? What tools and indicators do technicians have to gauge it?
J.C. Parets is a well-known technician and founder of All Star Charts. Today he shared a video of him answering some of the most common questions he gets about momentum. He begins by acknowledging that price is the primary thing he looks at but that momentum indicators are a great supplement to price. He explains that his favorite momentum indicator is the Relative Strength Index (RSI.) More specifically the 14-period RSI. There are several different ways to use this indicator, but J.C. tells us how he prefers to incorporate it into his process.
The indicator moves between a value of 0 and 100 where any value under 30 is considered oversold, and any value over 70 is considered overbought. Many people are mistaken in thinking that price being overbought is a sell signal. Instead, J.C. tells us, its bullish if price stays in an overbought range and that it signals an overwhelming amount of buyers.
J.C. tells us that the trick to identifying momentum is to train your eye to spot when RSI is moving in a bullish/bearish range. He uses the chart below to demonstrate what these two scenarios look like on an RSI chart.
J.C. highlights the fact that the study of momentum can be applied to all different asset classes (stocks, ETFs, commodities, currencies etc..) He then explains this:
“Momentum tends to behave in a certain way when there’s underlying strength in a market, and it tends to behave a certain way when there is overhead supply and an overwhelming amount of sellers”
He uses this daily chart of Tesla below, to illustrate this concept.
As you can see, throughout 2012 the stock moved sideways, but momentum stayed in a bullish range because RSI never hit oversold conditions. When the stock finally broke out in 2013, it did so from a position of power and went on to rally 400%!
Identifying when momentum is in a bullish/bearish range can greatly increase your odds of success. J.C. does a great job of addressing some of the common myths about RSI and momentum. Make sure to check out the video here!