Module 12

Momentum Indicators & Oscillators

Oscillators or Indicators

Now we will talk about momentum indicators

 The term “momentum” refers to the velocity of a price trend.

 This indicator measures whether a rising trend is accelerating or

decelerating or whether prices are declining at a faster or slower
pace.
Intraday Momentum Index - IMI

 The Intraday Momentum Index (IMI) was developed by Tushar

Chande. It is a cross-breed between the RSI and Candlestick
Analysis

 The calculation of the IMI uses the relationship between the

intraday opening and closing prices to determine whether the day
is "up" or "down." If the close is above the open, it is an up day. If
the close is below the open it is a down day. Therein lies its tie to
candlestick charting. For those familiar with Candlestick charting,
the IMI separates the black and white candlesticks and performs
an RSI calculation on the Candlestick bodies.
Relative Strength Index - RSI

The Relative Strength Index (RSI) is a popular oscillator used by

traders. It was first introduced by J. Welles Wilder in an article in
‘Commodities’ (now known as ‘Futures’) magazine in June, 1978.
Step-by-step instructions on calculating and interpreting the RSI are
also provided in Mr. Wilder's book, ‘New Concepts in Technical
Trading Systems ‘.

The name "Relative Strength Index" is slightly misleading as the RSI

does not compare the relative strength of two securities, but
the internal strength of a single security. A more appropriate name
might be "Internal Strength Index."
Relative Strength Index - RSI

The RSI is a fairly simple formula, but is difficult to explain without

pages of examples. The basic formula is:

100
RSI  100 
U
1
D

U = an average of upward price changes.

D = an average of downward price changes.
Relative Strength Index - RSI
100 - 100
1+ U/D
U=150 D=200

D=120

elative
100% trength
ndex
50%

Moving Average of RSI

(half to two thirds the
0% period of RSI)
Rate of Change - ROC

 The Price Rate-Of-Change (R.O.C.) indicator (percent method) is

calculated by dividing the price change over the last x-periods by
the closing price of the security x-periods ago. The result is the
percentage that the security's price has changed in the last x-
periods

 If the security's price is higher today than x-periods ago, the

R.O.C. will be a positive number. If the security's price is lower
today than x-periods ago, the R.O.C. will be a negative number.
Rate of Change - ROC
 Stochastic Oscillator
100%

90% 90%

100% 75%

50%
HHV
20
100% To improve it we calculate a 3
17.5 75% period MA of these percentages
we get :
15 50%
96.7%

10 91.6%
LLV

75%
C – LLV * 100 %K %D
HHV – LLV
Stochastic Oscillator

The Stochastic Oscillator Technical Indicator compares where a

security’s price closed relative to its price range over a given time
period. The Stochastic Oscillator is displayed as two lines. The main
line is called %K. The second line, called %D, is a Moving Average of
%K. The %K line is usually displayed as a solid line and the %D line is
usually displayed as a dotted line.
Stochastic Oscillator Formula

%K = (CLOSE-LOW(%K))/(HIGH(%K)-LOW(%K))*100

Where:
CLOSE — is today’s closing price;
LOW(%K) — is the lowest low in %K periods;
HIGH(%K) — is the highest high in %K periods.

%D = SMA(%K, N)

Where:
N — is the smoothing period
SMA — is the Simple Moving Average
 Oscillator
(Indicator)
Analysis
Analyze in three – Dimensions

TREND - Bullish or Bearish

AREA - Overbought or Oversold

DIVERGENCES - Bullish or Bearish

Oscillator
Direction
Direction – Up & Down

Momentum, like prices, move in trends.

This means that the techniques used for analysing price trends like
using moving averages can be used for appraising momentum
trends.

We must keep in mind that a trend reversal in momentum is not

always associated with a similar reversal in the price.

PRICE IS THE BOSS.

Oscillator
Extremes
Area – Overbought & Oversold

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

overbought to oversold levels.

In a sense, momentum reflects crowd psychology and measures the

intensity of the emotions of market participants
Psychology – Investor behavior
Conviction
Enthusiasm

Greed
Confidence Hope
Growing recognition Disbelief

Caution Apprehension
Skepticism
Shock & fear

Contempt Surrender
Disgust
Contrarian Theory

A trading theory that recommends making investments contrary to

the apparent direction of the market or commonly accepted wisdom.
The theory holds that if everyone is certain something is going to
happen, then it won't.

Contrarians also draw their conviction from the viewpoint that if

everyone believes the market will rise, they have already bought.
Thus, there are few investors remaining to create additional buying,
which means it is likely that the market will decline. Some mutual
funds have adopted a contrarian trading strategy as their main
focus.

So when your grandmother wants to buy…

Area – Overbought & Oversold

All momentum oscillators move from one extreme to another.

Some oscillators, like RSI and IMI are calculated in such a way that
they fluctuate between 0% and 100%. In these cases there is an
established level for the Overbought and Oversold lines in the above
cases 70% and 30%

Other oscillators, Like ROC or Momentum do not have maximum or

minimum levels so in this case we must calculate the Overbought and
Oversold lines ourselves.
 Oscillator
Divergences
Divergences– Bullish & Bearish

In a nutshell, divergence can be seen by comparing price action and

the movement of an indicator. It doesn't really matter what indicator
you use. You can use RSI, MACD, ROC, IMI, etc. Just think "higher
highs" and "lower lows".

If price is making higher highs, the oscillator should also be makin

higher highs. If price is making lower lows, the oscillator should also
be making lower lows.

If they are NOT, that means price and the oscillator are diverging
from each other And that's why it's called "divergence.“

divergence is used as a possible sign for a trend reversal

 Divergences– Bullish

If price is making lower lows (LL),

but the oscillator is making higher
2
lows (HL), this is considered to be
positive ( bullish) divergence. 4
1

This normally occurs at the end of a

down trend. After establishing a 3
5
second bottom, if the oscillator fails
to make a new low, it is likely that 2
the price will rise, as price and
momentum are normally expected 4
to move in line with each other. 1
5

A divergence is used as a possible 3

sign for a trend reversal
Bullish Divergence
 Divergences– Bearish

5
If the price is making a higher high
(HH), but the oscillator is lower high 3
(LH), then you have negative
(bearish) divergence.
1
4
This type of divergence can be found
in an uptrend After price makes that 2
second high, if the oscillator makes
3
a lower high, then you can probably
expect price to reverse and drop. 5
1
A divergence is used as a possible 4
sign for a trend reversal
2

Bearish Divergence
Divergences– Bullish & Bearish

As you can see from the images above, the divergence is best used
when trying to pick tops and bottoms. You are looking for an area
where price will stop and reverse.

The oscillators signal to us that momentum is starting to shift and

even though price has made a higher high (or lower low), chances are
that it won't be sustained.

A divergence is used as a possible sign for a trend reversal