What are Momentum Oscillators?
Momentum Oscillator is a type of leading indicator that measures the amount by which the price of given security has changed over a given period. These sets of indicators help gauge the strength and momentum of a trend as well as overbought and oversold market conditions. Being an unbound oscillator, the indicator does not have upside and downside limits, as is the case with other oscillators.
The fact that it is a leading indicator means it can detect a possible signal change that is about to occur. The ability to be in synchronism with price changes means the indicator is always of great help to both day traders and swing traders.
Momentum oscillator is calculated by dividing the current price with the price of the previous period, which is consequently multiplied by 100. For that reason, the indicator oscillates around 100, thus making it possible to identify oversold and overbought situations in a market. Values above 100 indicate positive momentum, while values below 100 indicate negative momentum.
Whenever the momentum oscillator reaches an extreme high or low, the same can be interpreted as a continuation of the current price trend, which can be upward or downward. Unlike most oscillators, Momentum Oscillator does not have an upper or lower boundary. Similarly, one must inspect the history of the momentum line to draw upper and lower boundaries.
By drawing upper and lower boundaries, you can be able to identify overbought and oversold situations when it comes to price action. The lack of upper and lower limits means interpreting overbought and oversold conditions is always subjective. For that reason, the price may continue to move higher or lower even when clearly in overbought or oversold conditions as per the plotted boundary limits.
For this reason, it is always important to use a momentum oscillator with another indicator that can be able to detect oversold and overbought conditions with ease.
Chande Momentum Oscillator
Chande Momentum Oscillator is an ideal indicator for detecting overbought and oversold conditions in addition to market momentum. The indicator measures the momentum of both up and down price movements but does not smooth the results like other indicators, thereby triggering more frequent oversold and overbought conditions.
The higher the absolute value in the indicator, the stronger the trend. Likewise, the lower absolute value, on the other hand, signifies market trading sideways or in a range.
Given the indicator oscillates between +100 and -100, a security price would be deemed overbought whenever it is above +50. Likewise, the price would be considered oversold if the oscillator is below -50.
Chande Momentum Oscillator can be relied upon to provide reliable buy and sell signals. For instance, a buy signal could be in play whenever the oscillator crosses above 0 signaling that prices could be headed higher.
Traders can also use the indicator to detect positive and negative price divergence to ascertain a potential price reversal. A negative divergence would, in this case, occur whenever the price of a security is trending higher while the Chande momentum oscillator is moving downward. A positive divergence, on the other hand, would be in focus whenever the price of underlying security is moving lower while the oscillator is rising.