• Relative Strength Index
  • Intraday Momentum Index
  • Rate of Change
  • Stochastic Oscillator
  • Commodity Channel Index

Momentum

  • “Momentum” refers to the velocity or the rate-of-change of a security’s price
  • Momentum indicators oscillates above or below an equilibrium line
  • All momentum indicators compare price changes from a period to another
  • They measure if a rising trend is accelerating or decelerating or whether prices are declining at a faster or slower pace

 

Relative Strength Index - RSI

  • Developed by J. Welles Wilder and featured in his 1978 book “New Concepts in Technical Trading Systems”
  • RSI compares the average price change of the bullish bars with the average change of the bearish bars of a security

RSI - Calculation

  • U = average of upward price changes
  • D = average of downward price changes
  • The default parameter for RSI is 14 periods

RSI - Interpretation

  • RSI fluctuates between 0 and 100 with equilibrium level at 50
  • As RSI goes above 50, upward momentum increases when it goes below 50, downward momentum increases
  • RSI is also used to reveal extreme price conditions
  • A security is considered overbought when RSI moves above 70 and oversold when RSI moves below 30

Intraday Momentum Index - IMI

IMI – developed by Tushar Chande and considered a cross-breed between the RSI and Candlestick Analysis

It uses the relationship between opening and closing prices to determine if the period is “Bullish” or “Bearish”

IMI separates the Bullish and Bearish candlesticks and performs an RSI calculation on the Candlestick bodies

IMI - Calculation

  • The IMI default look-back period is 14

IMI - Interpretation

  • IMI fluctuates between 0 and 100 with its equilibrium level at 50
  • As IMI goes above 50, upward momentum increases as IMI goes below 50, downward momentum increases
  • IMI is also used to reveal extreme price conditions
  • A security is considered overbought when IMI moves above 70 and oversold when IMI moves below 30

Rate of Change - ROC

  • Rate-Of-Change – a momentum oscillator that measures the percent change in price from one period to the next
  • The result is the percentage that the security’s price has changed in the last x-periods
  • ROC is identical to momentum oscillator with the only difference of momentum being normalized
  • The ROC has an equilibrium of 0 whereas the momentum oscillator fluctuates above or below 100

 

ROC - Calculation

  • ROC = Close Today – Close x periods ago
  • How a 4 look-back period ROC is calculated
  • The default look-back period is 21

ROC - Interpretation

  • Centerline Crossover: ROC fluctuates above or below its equilibrium level at zero
  • As the advance accelerates, ROC expands into positive territory
  • As the decline accelerates, ROC dives deeper into negative territory
  • ROC is used to reveal extreme price conditions
  • Traders can visually identify levels that caused previous turning points to identify overbought and oversold areas

Stochastic Oscillator

  • The Stochastic Oscillator is another popular momentum indicator developed in the late 1950s by George C. Lane
  • It compares the security’s closing price relative to its price range over a given period of time
  • The Oscillator does not follow price, it does not follow volume but rather follows the speed or momentum of prices

Stochastic - Calculation

  • Let’s check how a 5 period Stochastic is calculated
  • This plot is also known as the Fast Stochastic
  • As Fast %K is choppy and sharp it can be replaced with the Slow %K
  • For signals, add to the %K the %D line which is a x-period SMA of the Slow %K
  • The default look-back setting for the Stochastic is 5 for Fast %K, 3 for %D, 3 for Slow %K

Stochastic - Interpretation

  • Stochastic oscillator fluctuates between 0 and 100
  • Readings above 80 indicate that price is near its high
  • Readings below 20 indicate that price is near its low
  • It is used to reveal extreme price conditions
  • A security is considered overbought when %K moves above 80
  •  and oversold when %K drops below 20

Commodity Channel Index - CCI

  • The Commodity Channel Index (CCI), is a versatile indicator developed in 1980 by Donald Lambert
  • It can be used to identify the beginning of a new trend or warn of extreme conditions
  • Originally developed to identify cyclical turns in commodities, but the indicator can be successfully applied to other asset classes
  • CCI measures the current price level relative to an average price over a given period of time

 

CCI - Calculation

Constant is 0.015 and Mean Deviation is calculated as follows:

  • Subtract the 20-period SMA of TP from each period’s TP
  • Add their absolute values and divide by number of periods

CCI - Construction

  • The default look-back setting for the CCI Oscillator is 20 periods
  • The constant is at 0.015 to ensure that 70% – 80% of CCI values would fall between -100 and +100

CCI - Parameters and Interpretation

The CCI fluctuates above and below the zero level

Surges above +100 reflect strength and can signal the start of an uptrend

Plunges below -100 reflect weakness and can signal the start of a downtrend

Chartists can look for overbought or oversold conditions around ±200

As an unbound oscillator, extreme levels may depend on the volatility of the security

  • Oscillator Analysis
  • Direction
  • Area
  • Divergences

Three Dimensions Analysis

  • Direction – Bullish or Bearish
  • Area – Overbought or Oversold
  • Divergence – Bullish or Bearish

Direction – Bullish or Bearish

  • The same techniques that are used for analyzing price trends can be applied to momentum
  • When the indicator goes below its trendline we have the bearish signal
  • When the indicator goes below its moving average we have a bearish signal and vice versa
  • A trend reversal in momentum is not always associated with a similar reversal in the price – PRICE IS THE BOSS

Area - Overbought & Oversold

  • The financial markets are essentially driven by psychological forces
  • Our emotions move from one extreme to another, from greed to fear, from hope to despair
  • This is what causes momentum indicators to fluctuate from oversold to overbought levels
  • Momentum reflects crowd psychology and measures the intensity of the emotions of market participants
  • Banded oscillators fluctuate between 0% and 100%
  • For RSI and IMI extreme levels are those beyond 70% and 30%
  • For Stochastic extreme levels are those beyond 80% and 20%
  • Other oscillators are unbanded and traders must manually identify overbought and oversold lines
  • Extreme levels are manually determined where the indicator previously topped or bottomed
  • Extreme momentum readings indicate a possible correction in price
  • Signals are used by some traders to exit or enter new positions against the previous direction
  • A bullish signal occurs when the indicator goes below 30 and then crosses above it from below
  • A bearish signal occurs when the indicator goes above 70 and then crosses below it from above