Stop measuring price and start measuring demand and supply.
Momentum indicators have been calculated based on changes in price for decades. But that doesn’t make any sense – you’re just measuring the result, not the driving force. The driving force is demand and supply volume – the energy that drives prices. So why not use a Momentum Indicator that calculates buying and selling volume?
“Better Momentum is my most valuable trading tool.” Jack B.
“I am sold on your Better Momentum indicator.” Steve McG.
“You make volume as visual as price.” Ralph R.
That’s what Better Momentum does – that’s why it’s a “better” Momentum Indicator – plus it generates demand and supply signals. It’s one of my 3 non-correlated indicators. The other 2 are Better Sine Wave (measures price) and Better Pro Am (measures average trade size).
The trend changes when price and volume diverge
Momentum Indicator Divergence (Emini 2,097 tick)
“Why do markets turn?” The answer to this question is the secret to trading – the essence of speculating. Here’s my best answer:
- Markets bottom when all the sellers have sold (i.e. selling volume dries up)
- Markets top out when all the buyers have bought (i.e. buying volume dries up)
The next logical question then is “How do I know when all the sellers have sold or all the buyers have bought?” And that’s where measuring volume momentum comes in.
Let’s take the example of an uptrend. The move starts off with an explosion of buying that takes the market past a significant resistance level. In the early part of the move Professionals, large volume traders are active. On any dips the buyers step back in and continue to drive the market higher.
However, as the move progresses, Amateurs, who trade smaller volume, start to join in. Price continues to advance but eventually fewer and fewer buyers, with less and less buying volume, are participating. Professional traders start taking profits on any advances and the buying volume starts to decline.
Eventually, a point is reached when all the buyers have bought. The market tops out and price starts to reverse. Sometimes we move straight into a downtrend. At other times we get a final blow off buying climax – Amateurs desperate to finally get on board. But the trend has changed and it’s now time to exit Long positions and Short.
The chart above is a 2,097 tick bar chart of the Emini and highlights two reversals. The bottom was formed when a new low was made but the selling volume (as shown by the Better Momentum indicator) dried up. Similarly, the top was formed when a new high was made but the buying volume dried up. The red and white dots on the indicator and price bars indicate when buying and selling starts declining.
Measure changes in buying/selling volume, not price
Momentum Indicator Volume versus Price (Emini 699 tick)
The traditional Momentum Indicator, which seems to have no inventor, has been around forever. It has done a great job in the past of measuring the decline in Momentum as the uptrend move described earlier loses power. But it has a fatal flaw – it measures the change in price, not buying or selling volume.
In years gone by, the only timely data traders had available was price. Volume data was either not available or was delayed. But times have changed. My data feed not only tells me the volume of every single trade, but whether it took place on the bid or the ask! Extraordinary, really. So let’s make an improved Momentum indicator.
The Better Momentum indicator measures these waves of buying and selling volume and tells you when there is Bullish or Bearish Divergence. That is, in a downtrend, price is making new lows but the selling volume is becoming less and less – setting up for a reversal. And vice versa for an uptrend.
The chart above is a 699 tick bar chart of the Emini and shows the Better Momentum indicator (volume based) along side the traditional Momentum indicator (price based) with the same settings. As you can see for the highlighted turning point, the Better Momentum indicator correctly identified fewer sellers participating in the move and a likely reversal. The traditional Momentum indicator totally missed that a turning point was being formed.
Better Momentum generates 4 signals at turning points
Better Momentum Indicator Signals (Emini 4,500 tick)
The Better Momentum signals generated follow the progression of a change in trend:
- Exhaustion Selling or Buying (large cyan/blue dot)
- First Bullish or Bearish volume divergence (large red or white dot)
- Flush Selling or Buying volume (large yellow dot)
- And secondary Bullish or Bearish divergence signals (small red or white dot)
You need to wait for at least the First Bullish or Bearish divergence signal to plot before entering a reversal trade. And in some cases it is necessary to wait for the Flush volume pattern to signal – showing that the last of the sellers or buyers have been “flushed” out of the market and the trend can now reverse with little resistance.
The divergence algorithm used by the Better Momentum indicator is quite sophisticated. It doesn’t just look for the current peak to be less than the previous peak. But instead compares the current peak with a statistically significant prior peak.
There can be a slight delay in the printing of divergence signals as a peak has to be confirmed. However, this delay is not usually a problem for trading because the divergence signals lead the market.
Note: The Better Momentum signals plot in real-time on the price bars. But the signals are back-plotted on the momentum line itself. This is to show the peak or valley in momentum that actually generated the signal.
Confirm Momentum signals with non-correlated indicators
Better Momentum indicator with Better Sine Wave (Emini 4,500 tick)
The best way to use the Better Momentum indicator is with confirming, non-correlated indicators. Since the Better Momentum indicator is measuring waves of buying and selling, I use price cycles and average trade size as my confirming indicators.
High probability trades set up when you get all 3 signals lining up. For example:
- Bullish Divergence on Better Momentum with lower prices but less selling volume
- “End of Trend” signals on the Better Sine Wave indicator, and
- Professional buying on the Better Pro Am indicator (not shown)
The last trick to identifying high probability trades is using these 3 non-correlated tools (Better Momentum, Better Sine Wave and Better Pro Am) on multiple time frames.
- More screenshots of Better Momentum in action
Better Momentum Indicator: Emini (2,097 tick)
Better Momentum Indicator: Emini Short Signal (5 minute)
Better Momentum Indicator: Emini Long Signal (5 minute)
Better Momentum Indicator: Volume vs Price Euro (60 minute)
Better Momentum Indicator: Crude Oil (weekly)
Better Momentum Indicator: AAPL (weekly)
Better Momentum Indicator: TradeStation Inputs
- Case studies of Better Momentum in action
Follow these links to see case studies of Better Momentum in action:
- Emini Day Trading Video Example – 23 April 2009
- Emini Day Trading Example – 28 May 2009
- Another Emini Day Trading Video – 4 June 2009
- Emini Swing Trading Video – 16 June 2009
- Emini Swing Trading Update – 5 June 2009
- Emini 1,500 Tick Chart “Walk Through” – 6 May 2011
- Comparison between Better Momentum and Jurik RSX and VEL
This article should have convinced you to:
- Update your Momentum Indicator to measure volume not price. Modern data feeds now show you buying volume (demand) and selling volume (supply). Traditional Momentum Indicators only used price as a proxy for demand and supply because the volume data was not available when they were conceived.
- Only take reversal trades after you see Exhaustion Volume. Exhaustion Volume needs to be present to confirm a bottom or top – all the sellers need to have sold (i.e. selling volume dried up) or all the buyers need to have bought (i.e. buying volume dried up) for a reversal in the market to take place.
- Wait for Bullish or Bearish Divergence to signal a market is ready to turn. After Exhaustion Volume look for Divergence patterns where, in the case of a market bottom, price makes a lower low but selling volume makes a higher low (Bullish Divergence). In the case of a market top, price makes a higher high but buying volume makes a lower high (Bearish Divergence).
- Look for confirmation from non-correlated trading indicators. In my trading I use 2 non-correlated indicators: Better Pro Am to identify Professional and Amateur activity and Better Sine Wave to identify Support and Resistance levels. High probability trades can be found by combining these Bullish and Bearish Divergence signals on the Better Momentum indicator with Professional activity supporting a change in trend and breaks of key Support or Resistance levels.