Introduction: What is Momentum?

Momentum, much like in physics, is the tendency of an asset's price trend to continue in its current direction. Simply put, it's based on the principle that "what goes up tends to keep going up, and what goes down tends to keep going down." Momentum investors aim to catch these trends at an early stage and stay in the position until the trend loses its strength. This guide will show you not just the momentum indicators, but how to use them in concert, like a symphony, to make more accurate decisions.

The Momentum Investor's Toolkit

A single indicator is rarely enough. A strong strategy is born from the combination of indicators that provide different types of information.

1. Moving Averages (MA - 50 & 200-day): The Trend's Direction

   • Job: To determine the big picture, i.e., the direction of the main trend (uptrend or downtrend).
   • Usage: If the price is above the 50 and 200-day MAs, a strong uptrend is assumed; if below, a downtrend.

2. MACD (Moving Average Convergence Divergence): The Trend's Strength and Change

   • Job: To identify the strength of the current trend and a potential trend reversal.
   • Usage: When the MACD line crosses above the signal line, it's interpreted as a "buy signal"; when it crosses below, a "sell signal."

3. RSI (Relative Strength Index): The Market's Breath

   • Job: To measure whether an asset is in "overbought" or "oversold" territory, i.e., how close the trend is to taking a break or reversing.
   • Usage: Above 70 is considered overbought (the price may be too inflated), and below 30 is considered oversold (the price may have fallen too much).

The 3-Step Confirmation Strategy: Combining Indicators

Here is a strategy to create a more robust signal by combining these three indicators:

Step 1: Identify the Main Trend (Moving Averages)

First and foremost, determine the direction of the trend. Trading against the trend is like swimming against the current.

• Bullish Scenario: Is the price above the 50-day moving average (MA-50)? If yes, we are only looking for buying opportunities.
• Bearish Scenario: Is the price below the MA-50? If yes, we are only looking for selling (or shorting) opportunities.

Step 2: Get the Entry Signal (MACD)

Look for an entry signal in the direction of the main trend.

• Bullish Scenario: Is the MACD line crossing above the signal line? This is our potential entry trigger.
• Bearish Scenario: Is the MACD line crossing below the signal line?

Step 3: Confirm the Signal and Check Risk (RSI)

Subject your signal to a final confirmation.

• Bullish Scenario: When the MACD gives a buy signal, is the RSI below 70? If the RSI is already in the 80-90 overbought zone, you might be late to the party, and a correction could be near. Ideally, an RSI between 50-65 suggests there is still "fuel" for the rally.
• Bearish Scenario: When the MACD gives a sell signal, is the RSI above 30? If the RSI is already in the 10-20 oversold zone, the decline might be nearing its end.

Practical Example: TechCorp Inc. Stock

1. Trend Analysis: The price of TechCorp stock is above its 50-day MA. Decision: Only look for buying opportunities.
2. Signal Search: While monitoring the chart, we see the MACD line cross above the signal line. Decision: Potential buy signal received.
3. Confirmation: We check the RSI value at that moment. The RSI is at 62. This indicates it's not in the overbought zone and there is still potential for an upward move. Decision: Signal confirmed, a position can be entered.

Exit Strategy: To exit the position, one could wait for the MACD to cross downwards or for the RSI to exceed 75-80, indicating overextended conditions.

Risks of Momentum Investing

• Sudden Trend Reversals: Momentum strategies can incur losses during "choppy" periods when the market abruptly changes direction.
• False Signals: No indicator is perfect. Therefore, while the triple confirmation reduces the risk of false signals, it does not eliminate it.
• Discipline is Required: Sticking to the strategy and using stop-loss orders is vital to protect your capital.

Conclusion

Momentum investing is a powerful strategy that allows you to trade with the force of the market behind you. Instead of relying on a single indicator, identifying the trend with Moving Averages, getting the entry signal with MACD, and confirming that signal with RSI helps you make more informed and less risky decisions. Remember, even the best strategy is meaningless without strict risk management and discipline.

This guide is for financial literacy purposes and does not constitute investment advice.