Momentum Oscillator

Oscillators are the alternative to trend following approaches that were discussed in previous sections (trend lines, moving averages, Bollinger bands).

Oscillators are useful: 1. in side ways or trendless markets 2. to alert a trader of short term overbought or oversold conditions 3. to signal that a trend may be coming to an end before it reflects on the prices by displaying certain divergences.

We will discuss 3 Oscillators that are most commonly used. These indicators are usually used in the reports.

1. Momentum 2. Relative Strength Index (RSI) 3. Stochiastics

The Momentum Oscillator

Momentum measures the rate of change of price. To construct a momentum line, simply subtract the closing price from 10 days prior from the latest closing price. This negative or positive value is plotted around a midpoint line (usually 0 or 100). A shorter term momentum line is more sensitive while a longer term momentum line like a 40 day momentum results in a much smoother line.

How to use the Oscillator:

1. The oscillator helps to detect if the momentum is in line with the direction of the market. Any divergence could mean the market move is weakening.

2. Technical traders tend to use the crossing of the mid point as a buy or sell signal. It should be stressed here that the basic trend analysis is still the overriding consideration. Traders do not tend to take positions against the overall trend of the market.

The chart shows the weekly chart of EURO Stoxx 50 index (from 2013 to 2019) with a 10 week momentum oscillator above it. Weakening momentum as the market climbs higher is seen. This can be compared with the events that followed in the previous occasion. However, it is also observed that the latest buy signal generated has not closed yet.