Momentum oscillators are technical indicators used to measure the speed and strength of price movements in a given financial instrument. They help traders identify overbought or oversold conditions in the market and potential trend reversals.
Relative Strength Index
One of the most commonly used momentum oscillators is the Relative Strength Index (RSI). RSI compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset. RSI ranges from 0 to 100, where a reading above 70 indicates overbought conditions and a reading below 30 indicates oversold conditions.
Another popular momentum oscillator is the Moving Average Convergence Divergence (MACD). The MACD is computed as a differential of the 26-period Exponential Moving Average and the 12-period EMA. A nine-period EMA of the MACD, called the “signal line,” is then plotted on top of the MACD, which can be used as a trigger for buy and sell signals.
Yet another commonly used momentum oscillator is the stochastic oscillator that measures the current price of a security in relation to its high-low range over a given period of time. The stochastic oscillator ranges from 0 to 100, where a reading above 80 indicates overbought conditions and a reading below 20 indicates oversold conditions.
How to use momentum oscillators in trading
To use momentum oscillators, traders typically look for divergences between the oscillator and the price action of the asset they are trading. For example, if the price of an asset is making higher highs while the RSI is making lower highs, it could indicate that the trend is losing momentum and may be due for a reversal. Conversely, if the price is making lower lows while the RSI is making higher lows, it could indicate that the trend is gaining momentum and may continue.
Traders also look for crossovers of the oscillator and its signal line, as well as overbought and oversold conditions, to generate buy and sell signals. However, it is important to note that momentum oscillators are not always reliable and should be used in conjunction with other technical indicators and fundamental analysis for a more comprehensive analysis of market conditions.