Momentum oscillators

Momentum oscillators

Beginner

30th November 2019
Updated: 9th September 2020

What are Momentum Oscillators?

Momentum Oscillator is a type of leading indicator that measures the amount by which the price of a 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 sync with price changes means the indicator is always of great help to both day traders and swing traders.

Computation

The momentum oscillator is calculated by dividing the current price of a stock 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, the 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 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 detect oversold and overbought conditions.

Chande Momentum Oscillator

The 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.

The 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, signalling 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 an underlying security moves lower while the oscillator is rising.

By Harry Atkins
Harry joined us in 2019 to lead our Editorial Team. Drawing on more than a decade writing, editing and managing high-profile content for blue chip companies, Harry’s considerable experience in the finance sector encompasses work for high street and investment banks, insurance companies and trading platforms.
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