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INDICATORS: MOMENTUM OSCILLATORS
For the DIY trader, employing technical analysis indicators not only provides clues as to price movement but additionally helps discourage decision-making based on emotions. Momentum indicators, sometimes referred to as rate-of-change oscillators, are a popular technical analysis tool in modern trading known for broadening a trader's perspective - but what are they are and how do you apply them to your charts?
There are many different types of momentum indicators, with slightly varying formulas, but overall they are useful to traders who want to:
This brings us to oscillators, a popular branch of momentum indicators. Oscillation literally means movement back and forth, like a swing. So an oscillator in the technical analysis world measures the swings up and down in price over a specific time-frame. When applied to charts, we see the oscillators as fluctuating line(s) on the plot, and this help to give an indication of price direction and momentum. There are two types of momentum oscillators:
Centred Oscillators fluctuate above and below a central point (line),
Banded Oscillators fluctuate above and below two bands that signify extreme price levels (overbought/oversold).
Centred OscillatorsExamples of Centred Oscillators are the Examples of Centred Oscillators are the Moving Average Convergence/Divergence (MACD) & Rate of Change (ROC).
ROC is simply the percentage change in price from one period to the next i.e.
The plot forms an oscillator that moves over and under the centred line. It is a straightforward and useful tool for gauging momentum but is sometimes undeservedly overlooked due to its simplicity.
The MACD differs in that it finds the difference between a shorter- and a longer-term moving average and plots this as a single line. The default settings in most charting packages (including EzyChart) is a 12-day Exponential Moving Average (EMA) and a 26-day EMA. The further one EMA moves away from the other, the higher the oscillator reading.
Banded OscillatorsExamples of Banded Oscillators are the Relative Strength Index (RSI) & Stochastic.
The RSI oscillates between three zones - above 70 (overbought); between 70 and 30 (neutral) and below 30 (oversold). Most Banded Oscillators work on the basis that the indicator wants to trend towards 50, so there is a higher probability that the stock will trend upwards when the indicator is below 30.
The stochastic oscillator compares a stock's closing price to the range of its prices over a certain period of time. The theory behind this indicator is that prices on the uptrend close nearer their high whilst downward trending prices close nearer their low. In other words, momentum changes before price does. Signals or triggers occur when the %K (Oscillator) crosses the %D (Signal) line. It's a bullish signal when the Oscillator line rises above the Signal line and a bearish signal when it falls below the Signal line.
Final ThoughtsIf you consider adopting momentum indicators into your trading strategy, we recommend spending time experimenting with them first i.e. trying differing timeframe lengths and practicing with historical charts. If you'd like to see how to apply momentum oscillators to your charts, we've created this video that applies two well-known momentum indicators - the MACD and the RSI.
Before you go, it is important to reiterate that momentum indicators do not necessarily foretell the direction of price movement. When reading your charts, if you notice price momentum is starting to change, it is safer to wait until the actual price direction confirms this momentum signal.
First Published: 31 July 2018 - Copyright © Electronic Information Solutions Pty Ltd 1990 - . All Rights Reserved.
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