Measure of momentum is one of the key factor of technical analysis. Momentum measures the rate of changes in prices by comparing it with the price in the past. It can also show the strength of any up or down move in the price. The formula for calculation of momentum is quite simple
Current momentum = Current price – Past price (x days ago)
Momentum generally follows the price. If the prices are going higher momentum levels will also go higher and if the prices are going down momentum levels will also go down. But when a price makes a new high or low but the momentum doesn’t, it is called as divergence. Divergence can be positive or negative Positive divergence occurs when the price makes new low but the momentum indicator starts to move up or does not makes new low. Similarly negative divergence occurs when the price makes new high but the indicators starts to fall or doesn’t makes the new high.
How to trade momentum divergence
Momentum divergence signals the change of price direction. When the prices are making new high but the momentum level is not making new high, it is giving negative divergence then it is the signal to sell or to exit the long positions. At this level you can go short with the stop above the recent high. As target prediction is not possible with momentum divergence you can carry your position with trailing stop lose.
In the below chart of nifty you can see that prices are making new highs in Jan-February but the momentum indicator is not making high. This is the single to short with stop loss above the recent high.
In the same chart above we can see nifty making low in April-May but the momentum indicator is not making new low. This is the signal to exit the short positions or to go long with the stop loss below the recent low.
Its not always correct to just make trading decision of the basis of momentum indicator. You can combine more technical parameters like volume or chart patterns to make your trade more accurate.