MarketBasics : Trading and Settlement

What is a Stock Exchange?

A common platform where buyers and sellers come together to transact in stocks and shares. It may be a physical entity where brokers trade on a physical trading floor via an "open outcry" system or a virtual environment.

What is electronic trading?

Electronic trading eliminates the need for physical trading floors. Brokers can trade from their offices, using fully automated screen-based processes. Their workstations are connected to a Stock Exchange's central computer via satellite using Very Small Aperture Terminus (VSATs). The orders placed by brokers reach the Exchange's central computer and are matched electronically.

How many Exchanges are there in India ?

The Stock Exchange, Mumbai (BSE) and the National Stock Exchange (NSE) are the country's two leading Exchanges. There are 20 other regional Exchanges, connected via the Inter-Connected Stock Exchange (ICSE). The BSE and NSE allow nationwide trading via their VSAT systems.

What is an Index?

An Index is a comprehensive measure of market trends, intended for investors who are concerned with general stock market price movements. An Index comprises stocks that have large liquidity and market capitalisation. Each stock is given a weightage in the Index equivalent to its market capitalisation. At the NSE, the capitalisation of NIFTY (fifty selected stocks) is taken as a base capitalisation, with the value set at 1000. Similarly, BSE Sensitive Index or Sensex comprises 30 selected stocks. The Index value compares the day's market capitalisation vis-a-vis base capitalisation and indicates how prices in general have moved over a period of time.

How does one execute an order?

Select a broker of your choice and enter into a broker-client agreement and fill in the client registration form. Place your order with your broker preferably in writing. Get a trade confirmation slip on the day the trade is executed and ask for the contract note at the end of the trade date.

Why does one need a broker?

As per SEBI (Securities and Exchange Board of India.) regulations, only registered members can operate in the stock market. One can trade by executing a deal only through a registered broker of a recognised Stock Exchange or through a SEBI-registered sub-broker.

What is a contract note?

A contract note describes the rate, date, time at which the trade was transacted and the brokerage rate. A contract note issued in the prescribed format establishes a legally enforceable relationship between the client and the member in respect of trades stated in the contract note. These are made in duplicate and the member and the client both keep a copy each. A client should receive the contract note within 24 hours of the executed trade. Corporate Benefits/Action.

What is a book-closure/record date?

Book closure and record date help a company determine exactly the shareholders of a company as on a given date.

Book closure refers to the closing of register of the names or investors in the records of a company. Companies announce book closure dates from time to time. The benefits of dividends, bonus issues, rights issue accruing to investors whose name appears on the company's records as on a given date, is known as the record date.

An investor might purchase a share-cum-dividend, cum rights or cum bonus and may therefore expect to receive these benefits as the new shareholder. In order to receive this, the share has to be transferred in the investor's name, or he would stand deprived of the benefits. The buyer of such a share will be a loser. It is important for a buyer of a share to ensure that shares purchased at cum benefits prices are transferred before book-closure. It must be ensured that the price paid for the shares is ex-benefit and not cum benefit.

What is the difference between book closure and record date?

In case of a record date, the company does not close its register of security holders. Record date is the cut off date for determining the number of registered members who are eligible for the corporate benefits. In case of book closure, shares cannot be sold on an Exchange bearing a date on the transfer deed earlier than the book closure. This does not hold good for the record date.

What is a no-delivery period?

Whenever a company announces a book closure or record date, the Exchange sets up a no-delivery (ND) period for that security.

During this period only trading is permitted in the security. However, these trades are settled only after the no-delivery period is over. This is done to ensure that investor's entitlement for the corporate benefit is clearly determined.

What is an ex-dividend date?

The date on or after which a security begins trading without the dividend (cash or stock) included in the contract price.

What is an ex-date?

The first day of the no-delivery period is the ex-date. If there is any corporate benefits such as rights, bonus, dividend announced for which book closure/record date is fixed, the buyer of the shares on or after the ex-date will not be eligible for the benefits.

What is a Buy Back?

As the name suggests, it is a process by which a company can buy back its shares from shareholders.

A company may buy back its shares in various ways: from existing shareholders on a proportionate basis; through a tender offer from open market; through a book-building process; from the Stock Exchange; or from odd lot holders.

A company cannot buy back through negotiated deals on or off the Stock Exchange, through spot transactions or through any private arrangement. Clearing and Settlement

What is a settlement cycle?

The accounting period for the securities traded on the Exchange. On the NSE, the cycle begins on Wednesday and ends on the following Tuesday, and on the BSE the cycle commences on Monday and ends on Friday.

At the end of this period, the obligations of each broker are calculated and the brokers settle their respective obligations as per the rules, bye-laws and regulations of the Clearing Corporation.

If a transaction is entered on the first day of the settlement, the same will be settled on the eighth working day excluding the day of transaction. However, if the same is done on the last day of the settlement, it will be settled on the fourth working day excluding the day of transaction.

What is a rolling settlement?

The rolling settlement ensures that each day's trade is settled by keeping a fixed gap of a specified number of working days between a trade and its settlement. At present, this gap is five working days after the trading day. The waiting period is uniform for all trades.

When does one deliver the shares and pay the money to broker?

As a seller, in order to ensure smooth settlement you should deliver the shares to your broker immediately after getting the contract note for sale but in any case before the pay-in day. Simliarly, as a buyer, one should pay immediately on the receipt of the contract note for purchase but in any case before the pay-in day.

What is short selling?

Short selling is a legitimate trading strategy. It is a sale of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers take the risk that they will be able to buy the stock at a more favourable price than the price at which they "sold short."

What is an auction?

An auction is conducted for those securities that members fail to deliver/short deliver during pay-in. Three factors primarily give rise to an auction: short deliveries, un-rectified bad deliveries, un-rectified company objections.

Is there a separate market for auctions?

The buy/sell auction for a capital market security is managed through the auction market. As opposed to the normal market where trade matching is an on-going process, the trade matching process for auction starts after the auction period is over.

What happens if the shares are not bought in the auction?

If the shares are not bought at the auction i.e. if the shares are not offered for sale, the Exchange squares up the transaction as per SEBI guidelines. The transaction is squared up at the highest price from the relevant trading period till the auction day or at 20 per cent above the last available Closing price whichever is higher. The pay-in and pay-out of funds for auction square up is held along with the pay-out for the relevant auction.

What is bad delivery?

SEBI has formulated uniform guidelines for good and bad delivery of documents. Bad delivery may pertain to a transfer deed being torn, mutilated, overwritten, defaced, or if there are spelling mistakes in the name of the company or the transfer. Bad delivery exists only when shares are transferred physically. In "Demat" bad delivery does not exist.

What are company objections?

A list documenting reasons by a company for not transferring a share in the name of an investor is called company objections. Rejection occurs due to a signature difference, or fake shares, or forgery, or if there is a court injunction preventing the transfer of the shares.

What should one do with company objections?

The broker must immediately be notified. Company objection cases should be reported within 12 months from the date of issue of the memo for the original quantity of share under objection.

Who has to replace the shares in case of company objections?

The member who has sold the shares first on the Exchange is responsible for replacing the shares within 21 days of the Exchange being informed. Company objection cases that are not rectified or replaced are normally auctioned.

How does transfer of physical shares take place?

After a sale, the share certificate along with a proper transfer deed duly stamped and complete in all respects is sent to the company for transfer in the name of the buyer. Once the transfer is registered in the share transfer register maintained by the company, the process of transfer is complete.

Pivot Point Trading:

We often hear market analysts or experienced traders talking about an equity price nearing a certain support or resistance level, each of which is important because it represents a point at which a major price movement is expected to occur. But how do these analysts and professional traders come up with these so-called levels? One of the most common methods is using pivot points.

First Some History:

Using pivot points as a trading strategy has been around for a long time and was originally used by floor traders. This was a nice simple way for floor traders to have some idea of where the market was heading during the course of the day with only a few simple calculations.

Pivot points are yet another useful tool that can be added to any trader's toolbox. It enables anyone to quickly calculate levels that are likely to cause price movement.

The reason pivot point trading is so popular is that pivot points are predictive as opposed to lagging. You use historical information of the previous day to calculate potential turning points for the day you are about to trade (present day).

Before we go into how you calculate pivot points,we just want to point out that we have put an online pivot point calculator for free HERE

Because so many traders follow pivot points you will often find that the market reacts at these levels. This will give give us an opportunity to place our trade.

How to Calculate Pivot Points?

There are several different methods for calculating pivot points, the most common of which is the five-point system. This system uses the previous day's high, low and close, along with two support levels and two resistance levels (totaling five price points) to derive a pivot point.

The equations are as follows:

Resistance 2 = Pivot + (R1 - S1)

Resistance 1 = 2 * Pivot - Low

Pivot Point = ( High + Close + Low )/3

Support 1 = 2 * Pivot - High

Support 2 = Pivot - (R1 - S1)

As you can see from the above formula, just by having the previous days high, low and close you eventually finish up with 5points, 2resistance levels, 2support levels and the actual pivot point.

If the market opens above the pivot point then the bias for the day is for long trades as long as price remains above the pivot point.

On the 12th December 06 the daily chart of the BSE Sensex had the following:

High - 13223;

Low - 12808;

Close - 13181.3 ;

This gave us:

Resistance 2 = 13485.77;

Resistance 1 = 13333.53;

Pivot Point = 13070.77;

Support 1 = 12918.53;

Support 2 = 12655.77;

The three most important pivot points are R1, S1 and the actual pivot point.

The general idea behind trading pivot points is to look for a break of R1. By the time the market reaches R2 the market will already be overbought and these levels should be used for exits rather than entries.

A perfect set up would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2.

Have a look at the 5 minute chart on 13 December 06 below of the BSE Sensex:

In the chart above we have the perfect set up as the market opened above the pivot level on the 13th and then stalled slightly at R1 only to break through and go on to R2. You would enter on a break of R1 with a target of R2.

Advanced :

A more advanced method is to use the cross of two moving averages as a confirmation of a breakout. You can even use combinations of indicators to help you make a decision. It might be the cross of two averages or you could add the MACD indicator as shown in the example below.

Trading Rules:

• Price opens above the Pivot Point line, this confirms the bias for the day to go long.
• Enter on the break of R1 together with the MACD showing buy.
• Go for R2 as your target and move your stop up depending on the risk you are prepared to take.
• Place your stop just below the lowest candle that formed for the day before price broke through R1.

Daily chart of the BSE Sensex with the MACD set at 12,26,9:

Mess around with a few of your favorite indicators to help determine an entry around a pivot level but remember the signal is a break of a level and the indicators are just confirmation.

Moving Average Convergence Divergence - MACD:

The MACD is a trend-following momentum indicator that shows the relationship between two moving averages of price. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the "signal line", is then plotted on top of the MACD, functioning as a trigger for buy and sell signals.

First Some History:

Developed by Gerald Appel, Moving Average Convergence/Divergence (MACD) is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trend-following characteristics. These lagging indicators are turned into a momentum oscillator by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits.

Benefits of the MACD:

One of the primary benefits of MACD is that it incorporates aspects of both momentum and trend in one indicator. As a trend-following indicator, it will not be wrong for very long.

The use of moving averages ensures that the indicator will eventually follow the movements of the underlying security. By using exponential moving averages, as opposed to simple moving averages, some of the lag has been taken out.

MACD Setup:

The default settings for the MACD which we will use are:

Slow moving average - 26 days

Fast moving average - 12 days

Signal line - 9 day moving average of the difference between fast and slow.

All moving averages are exponential.

Although there are three moving averages mentioned you will only see two lines. The simplest method of use is when the two lines cross. If the faster signal line crosses above the MACD line (The MACD line is calculated by the difference between the 26-day exponential moving average and the 12-day exponential moving average) then a buy signal is generated and vice versa.

It is also used as an overbought and oversold indicator. The higher above the zero both lines are the more overbought it becomes and the lower below the zero line both lines are the more oversold it becomes.

It may also lead to a stronger signal if the signal line crosses down when it is overbought and crosses up when it is oversold. The last common use of MACD is that of divergence.

If the MACD is making new lows and the price of the security is not making new lows that is one form of divergence (bullish divergence). Also, if the MACD has made a high and starts to head down but price continues up that is another type of divergence (bearish divergence) and may lead to an indication of a change in direction. (but more on that later in this course)...

There are many ways to trade the MACD but one of our favourites are too use two different time frames. All you do is establish a trend in a higher time period than the one you intend to trade. For our higher time frame we like to use the 30 min chart and then drop down to the 5 min chart when conditions have been met on the 30 min chart..

 As you can see from the 30 min chart example of the BSE Sensex below there was a buy signal on 12th December 06. The chart below (red arrow) shows the fast 9-day signal EMA (thin red line) crossing over the MACD line EMA (thin blue line).

The histogram represents the difference between MACD and its 9-day EMA. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

After confirming the signal on the 30 min chart we then dropped to the lower time frame 5 min chart of the BSE Sensex and bought the rallies where the red arrows show, confident to stay long (to buy) as long as our higher time period MACD trend in the 30 min stayed intact. If the 30 min MACD signal line were to cross down we would have closed all long positions.

Conclusion:

The MACD is not particularly good for identifying overbought and oversold levels even though it is possible to identify levels that historically represent overbought and oversold levels. The MACD does not have any upper or lower limits to bind its movement and can continue to overextend beyond historical extremes.

Also the MACD calculates the absolute difference between two moving averages and not the percentage difference. The MACD is calculated by subtracting one moving average from the other. As a security increases in price, the difference (both positive and negative) between the two moving averages is destined to grow. This makes its difficult to compare MACD levels over a long period of time, especially for stocks that have grown exponentially.

Having said that the MACD still is and will always be one of the few indicators that all traderslove and use daily and in many ways it is like seeing an old familiar friend you know you can rely on.

Relative Strength Index - RSI:

With credit to Chartfilter:

Very basically, "buy" signals on the RSI are considered to be readings of 30 or less (the security is considered oversold) and "sell" signals are considered to be RSI values of 70 or greater (the security is considered overbought). Depending on the technician and price volatility, there are various other qualifiers and nuances that can be incorporated into a signal.

First Some History:

Relative Strength Index was developed by J.Welles Wilder Jr. and introduced in his book 'New Concepts In Technical Trading Systems'. It is one of the most popular technical tools around. The RSI is plotted on a vertical scale of 0 to 100. The 70% and 30% levels are used as warning signals.

An RSI above 70% is considered overbought and below 30% is considered oversold. An overbought or oversold condition merely indicates that there is a high probability of a counter reaction. It is an indication that there may be an opportunity to buy or sell, but does not provide the final signal. RSI signals should always be used in conjunction with trend-reversal signals offered by the price itself.

Calculation:

Relative Strength Index (RSI) measures the strength of all upward movement against the strength of all downward movement in a specified time frame.

The mathematical formula for RSI is shown below:

RSI = 100 - [100/(1+RS)]

RS = average of n day's up closes / average of n day's down closes.

The most common parameter for RSI is period 14, although users can pick their favorite period of time if they wish. It is one of the most popular oscillators that works well in range-bound market.

Signals:

Tops & Bottoms, Failure Swings, Divergence Traders watch for double tops or what Wilder referred to as "failure swings". If the RSI makes a double top formation, with the first top above 70% and the second top below the first, you get a sell signal when the RSI falls below the level of the dip. Conversely, a double bottom at or below 30% (with the first low below 30% and the second at or above the same level) gives you a buy signal when the RSI breaks above the previous peak.

These failure swings can lead to divergences between the price action and the RSI. For example, a divergence occurs when a market makes a new high or low, but the RSI fails to set a matching new high or low. A divergence can be an indication of an impending reversal. Divergences are the most important signal provided by RSI.

Our Use Of RSI:

Our favorite use of RSI is that of divergence as suggested by Wilder himself.. When the security you are trading makes a new high and the RSI turns down that is bearish divergence. The same is true of bullish divergence. When price makes a new low (red line) and the RSI turns up (blue line) that is bullish divergence as in the 30 min chart of the BSE Sensex shown below:

We also prefer to see divergence at major tops and bottoms. That is to say, if we have been in a down trend for some time as shown in the chart above and price has gone past a reading of 20 on the RSI AND we see divergence then we are a lot more confident that price has in fact bottomed.

We don't like to use RSI as a sole trigger for a new position but rather like to use it in combination with other indicators to help build a picture. You will notice that in most cases of divergence the security makes a low as does the RSI, then the RSI begins to turn up but the security continues down.

We wait for the security to make a new low and the RSI to come down but not as low as the previous low and that is the point where action can be taken. The fact that the RSI has not dropped lower than its previous low and the price has, is the point of recognition.

If we also have a break of a trendline or it has reach a projection or some other confirming analysis then we would enter a trade. For the purposes of this illustration we will use a break of a trendline to confirm that trend direction has indeed changed.

Have a look at the 30 min chart below of the BSE Sensex:

In the chart above we have the perfect set up as the market showed oversold conditions and divergence on the RSI, price came back up and broke our trendline (orange line) at which stage we would have placed our entry to go long the market.

Advanced:

A more advanced method is to use Bollinger Bands for your target and exit strategy after your entry. Below is a 30min chart of the BSE Sensex with RSI set at 14, and Bollinger Bands set at 20.

Trading Rules (Going long):

• Identify divergence between the security and RSI.
• Confirm oversold conditions with a reading below 20 on the RSI.
• Draw a trendline (orange line) and enter when price breaks the trendline (Point A).
• Exit when price retraces back to the middle Bollinger Band line (Point B).
• Your stop loss will be whenever price hits the lower Bollinger Band line after your entry.

Conclusion:

• The RSI is a momentum indicator, or oscillator, that measures the relative internal strength of a market (not against another market or index).
• As with all oscillators, RSI can provide early warning signals but should be used in conjunction with other indicators.
• Divergences are the most important signal provided by RSI.

With credit to Chartfilter:

Thank you for joining us in this lesson.

The Indiadaytrading Team With Albatross Trade And Investments Team .

Stochastic Oscillator:

Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator that shows the location of the current close relative to the high/low range over a set number of periods.

In this lesson we will show one very accurate trading method we like using the Stochastic Oscillator.

First Some History:

Lane observed that as prices increase in an up trend, closing prices tend to be closer to the upper end of bars and in a down trend closing prices tend to be nearer the lower end of bars. Lane developed stochastics to discern the relationship between the closing price and the high and low of a bar.

Typically used to identify overbought and oversold conditions the indicator consists of two lines: % K and %D.

These two lines fluctuate in a vertical range between 0 and 100. Readings above 80 are considered overbought and readings below 20 are considered oversold.

Calculation:

14 is a popular number of periods for calculation:

 A 14-day %K (14-period Stochastic Oscillator) would use the most recent close, the highest high over the last 14 days and the lowest low over the last 14 days. The number of periods will vary according to the sensitivity and the type of signals desired.

Slow versus Fast versus Full:

There are three types of Stochastic Oscillators: Fast, Slow, and Full. The Fast and Full Stochastic is discussed later.

For the purposes of this trading method we will only be looking at the Slow Stochastic Oscillator.

The driving force behind all three Stochastic Oscillators is %K (fast), which is found using the formula provided above.

Below is a 1 hour chart of the BSE Sensex showing the stochastic settings for this trading method:

Be sure to set the slow stochastic oscillator to K period:15, D period 5 and MA period 5.

Advanced:

Look for bullish divergence between price and the stochastic oscillator as shown in the image below:

A 1 hour chart of the BSE Sensex showing divergence and the stochastic oscillator at 14:

Trading Rules (Going Long):

• Identify stochastic divergence, in the image above this is represented by two lines, make sure price is on the move down (green line) and the stochastic oscillator moving up (yellow line) from OVERSOLD conditions (blue arrow).
• Enter the market when price breaks the area of resistance.
• Place your stop below the lowest candle after divergence occured.
• Place a trailing stop of 30 pips or depending on your style of trading you could also draw in Bollinger Band lines and wait for price to retrace to the middle Bollinger Band line as an exit signal.

Conclusion:

Readings below 20 are considered oversold and readings above 80 are considered overbought. However, a reading above 80 is not necessarily bearish or a reading below 20 bullish. A security can continue to rise after the Stochastic Oscillator has reached 80 and continue to fall after the Stochastic Oscillator has reached 20.

Some of the best signals occur when the oscillator moved from overbought territory back below 80 and from oversold territory back above 20 but as usual it is best to use the oscillator together with some other indicator as shown above to filter out whipsaws and false signals.

Thank you for joining us in this little trading method.

The Indiadaytrading Team

With Albatross Trade And Investments Team

Trendlines:

Technical analysis is built on the assumption that prices trend. Trend Lines are an important tool in technical analysis for both trend identification and confirmation. A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance.

First Some History:

Using trend lines as a tool to technically analyze the markets has been around for a long time and was originally also used by floor traders. They saw that prices can only go in three directions; up, down, and sideways. A long line of past price ranges together gives you a pattern. There will be plenty of ups and downs along the line but you should still be able to discern a general direction up, down, or sideways.

How to draw a trend line:

The first consideration when looking at any market is the direction of the long term trend. Trendlines illustrate the direction of the market movement and provide a primary consideration in any analysis. Keeping in mind that the market can move inmore than one direction the following applies when drawing a trend line:

Uptrends consist of a series of successively higher highs and lows.

Drawing trendlines during an up trending market: The trendlines above have been drawn by connecting as many successive lows as possible (along the bottom of the price range). An up trending trendline represents major support for prices as long as it is not violated.

Downtrends consist of a series of successively lower highs and lows.

Drawing trendlines in a down trending market: Down trending trendlines are drawn by connecting as many successive highs as possible as shown above (along the top of the price range). A down trending trendline represents major resistance for prices as long as it is not violated.

Support and Resistance:

An important concept in the use of trendlines as mentioned above is that of support and resistance. A continued trend is based on underlying support for prices in the market, for whatever reason. Similarly, there is resistance to higher prices built into the market. The trendline is one way to capture and illustrate these zones of support and resistance.

As long as the market stays within these zones of support and resistance, as shown by a trendline, the trend is sustained. Any penetration through a trendline warns of a possible change in trend. We may not know the reason behind such a change, but we do know that for some reason the support or resistance for a market is changing.

The general idea behind trading trendlines is to look for a break of the trend in the opposite direction.

A perfect set up would be for the market to break through an established trendline A-B as illustrated below. You could add Bollinger Bands and wait for price to also break through the middle line of the Bollinger Band at Point C before placing your trade.

Below is a 4 hour chart of the BSE Sensex:

Advanced:

A more advanced method is to use the break of the trendline A-B as confirmation of the overall trend change, then wait for price to hit point C (Purple Arrow) and then use the Commodity Channel Index (CCI) indicator to reaffirm the trade.

Trading rule:

• Wait for price to break the trendline A-B.
• Place your trade when price hits the middle Bollinger Band line at Point C (Purple Arrow), but only if the CCI shows a cross above 100 as at Point E illustrated on the chart below.
• Exit the trade when price hits the upper Bollinger Band line at Point D (Yellow Arrow).
• Your stop is the first close of a candle below the lower Bollinger Band line.

Daily chart of the BSE Sensex with the Commodity Channel Index indicator (CCI) set at 34:

Conclusion:

Trend lines can offer great insight, but if used improperly, they can also produce false signals. Other items - such as horizontal support and resistance levels or peak-and-trough analysis - should be employed to validate trend line breaks. While trend lines have become a very popular aspect of technical analysis, they are merely one tool for establishing, analyzing, and confirming a trend.

Trend lines should not be the final arbiter, but should serve merely as a warning that a change in trend may be imminent. By using trend line breaks for warnings, investors and traders can pay closer attention to other confirming signals for a potential change in trend.

Thank you for joining us in this lesson.

The Indiadaytrading Team

With Albatross Trade And Investments Team.

Momentum Trading:

One of the most basic and widely used indicators is that of momentum.

Before I go on to tell you how we can use the momentum indicator to trade with, I want to explain the difference between a leading and a lagging indictor.

Nearly all indicators are lagging indicators. That is to say that the price must first move in order for the indicators to react. So you will inevitable get a situation e.g. where the market will rise shortly followed by the indicator. This is where the term lagging comes form in trading.

On the other hand, an indictor that forecasts the move before it happens is called a leading indictor.

If for example the indictor peaks and then turns down before price peaks and turns down then that would be a leading indictor.

You can use most indicators as both depending on how you mix them with time frames and settings.

The reason I mention this is that momentum can be a very good leading indictor when used in a particular way.

Let's first talk about what a momentum indictor is - simply a visual reference point of whether a security is rising or falling and how fast that rise or fall is.

Construction of the indictor is simple - just subtract the close of the security X (whatever period you want)days ago from today's close.

The resulting number can then be plotted around a zero line. For example let's say we were looking at a 10 period momentum indictor. You would simply deduct today's close from the close 10 days ago. If the close was higher than the close 10 days ago then it would be plotted above the zero line. If on the other hand the close was lower than the close 10 days ago, the it would be plotted below the zero line.

As you would expect - if the momentum line is rising and above the zero line we can interpret that as a strong bullish trend. If the momentum line is below the zero line and falling we can interpret that as a strong bearish trend.

As you can see from our first chart, momentum can be a very good confirmation indictor. If you were using a moving average or a trend line to help determine trend, then a cross above or below the zero line could be just the confirmation you need.

In the example above I was using a 34 period exponential average of the close.

Price came back up and closed above the average and shortly afterwards the momentum indictor also closed above the zero line confirming the move.

Not only that but the momentum line has remained above the zero line since the cross over. This would give you confidence that the trend is still in force.

In our next chart there are two important points I want you to take note of - the first is that of divergence.

Divergence is when an indictor does the opposite of what the price on the chart is doing. In our example the momentum indictor started to turn down but the price continued up. This is bearish divergence. Often when this happens it is an early warning that the market is in an exhaust move. The indictor is giving us an advanced warning that the market might be getting ready for a move in the opposite direction from which it was previously heading. The opposite is obviously true for bullish divergence.

Next I want you to look at the three points I have marked as extreme on the chart. Forget the reading at these points - visually you can see that the three points are lower than the other points around them. When you have an extremely low reading in an uptrend then you have a good trading opportunity to go long. If you have an extremely high reading in a downtrend then you have a good opportunity to go short.

You could further confirm this by a shorter moving average crossing a longer average or as I have done with a little trend line. Nice, simple technique that will keep you on the right side of the trend and give you some great entry points.

Momentum Day Traders' Glossary :

Arbitrage - The simultaneously purchase and sale of identical securities to benefit from a discrepancy in their price.

Ask - Also known as 'offer' - The price at which traders are prepared to sell a security. Bear - Trader who believes prices will move lower.

Bear Market - A market that is in decline (falling). A succession of lower peaks and valleys.

Bid - The price at which traders are prepared to pay for a security.