Trader Tip: Momentum Oscillators At Blue Point Trading we often discuss the use of indicators in our Trade Plans that we use on a day to day basis to trade. In this Blog post we want to discuss a class of chart indicators called momentum oscillators. We first should understand what they are and later we shall discuss some typical uses for them.
Momentum oscillators measure the rate-of-change of an instrument’s price. The faster the instrument rises or falls, the greater the period-over-period price changes, and the momentum increases. Typically this movement in momentum is above and below a zero line or within a band range (price rises or falls – long or short). Another way to look at this is the price speed. When markets rally strong momentum is high. When markets stall momentum is flat. Hence, a momentum oscillator can help one understand the current strength of a market move and when it potentially might be completed.
That being said, one should note that momentum oscillators are “price derived” and hence can be lagging. This means they are great when markets are in a strong trend, but if the markets are chopping, the oscillators can be misleading. This is why Trade Plans that solely rely on momentum oscillators will be challenging. However, they can serve as very good trade tools set within the overall context of a Trade Plan.
The simplest way to calculate an oscillator is to subtract the difference between two moving averages. This will create a line above and below a zero line. This is often called a “centered oscillator.” Centered oscillators are good for identifying the strength or weakness, or direction, of momentum behind an instrument’s move. Other ways to calculate are more complex, to create a percentage relative fixed band. These are called “banded oscillators.” Banded oscillators fluctuate above and below two bands that are good for signify extreme price levels.
Though there are many oscillator indicators available, typical centered oscillators are the: MACD, ROC and the simple Price Oscillator. Typical banded oscillators are: Stochastics, RSI and CCI. The biggest difference between centered oscillators and banded oscillators is the latter’s ability to identify extreme readings, as well as having the ability to have a constant number that can span across multiple instruments.
Some typical uses for momentum oscilators are:
- Positive and negative divergences from actual pricing.
- Filters to ensure you are trading in the correct direction.
- Counter trend trading indicators to measure over bought and over sold conditions.
Take a look at these momentum oscillators and begin to use them as additional tools in your personal trader ToolBox when developing your Trade Plans. Below is a video presentation on this topic.
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