Introduction
Tushar Chande, a renowned technical analyst and author, is the developer of the Chande Momentum Oscillator (CMO), along with several other technical indicators, such as the Aroon Oscillator, the QStick, and the Stochastic RSI.
Chande has also made significant contributions to the field of behavioral finance by studying the effects of cognitive biases and emotional decision-making on financial markets. He has authored several books on technical analysis, including “Beyond Technical Analysis” and “The New Technical Trader.” Chande’s work has had a tremendous impact on the field of technical analysis, and his indicators are widely used by traders and investors worldwide.
The purpose of CMO is to measure the momentum of a security or asset by comparing its current price to its previous closing price over a specified time frame. It is calculated by subtracting the sum of losses from the sum of gains over the specified time period and dividing the result by the sum of all price movements during that time. The resulting figure is then normalized to a scale ranging from -100 to +100.
The CMO can be employed in various ways, but one of its most common uses is to identify overbought and oversold conditions in a security or asset. Traders may use the CMO to detect discrepancies between the indicator and the security’s price, which could suggest a potential trend reversal.
When the CMO reading is above zero, it typically indicates that the security’s price is gaining momentum. Conversely, a reading below zero suggests that momentum is decreasing. Traders may also keep an eye out for crossovers between the CMO and its moving average as potential signals of changes in momentum.
While the CMO can be a useful tool, it should not be the sole basis for trading decisions. Other forms of analysis, such as market trends, news events, and broader economic conditions, should also be considered. As with any technical analysis indicator, the CMO should be used in conjunction with other sources of information.
Looking for information on Chande Momentum Oscillator stock screener? Click here.
Computing the Chande Momentum Oscillator
By evaluating the present price of a security or asset in relation to its prior closing price within a specified time frame, the Chande Momentum Oscillator (CMO) assesses the level of momentum exhibited by the said security. To calculate the CMO, you need to find the difference between the sum of gains and losses over the specified time period and divide that difference by the sum of all price movement over that same time period. The resulting value is then expressed as a percentage and normalized to a range between -100 and +100.
The formula for calculating the CMO is:
CMO = ((Sum of Gains - Sum of Losses) / (Sum of Gains + Sum of Losses)) x 100
Here, the “Sum of Gains” is the total of all price increases over the selected time period, and the “Sum of Losses” is the total of all price decreases over the same period. The time period used for the calculation is usually set to 20 or 22 days, but traders can adjust it to suit their preferences and the security being analyzed.
Interpreting the Chande Momentum Oscillator
As per experts in technical analysis, the Chande Momentum Oscillator (CMO) is a useful instrument that offers insights into the momentum of a particular security. It has the ability to detect instances of overbought and oversold levels, as well as indications of possible shifts in the prevailing trend.
Analyzing the direction and magnitude of the CMO is crucial in understanding it. Positive CMO values suggest that the security’s momentum is increasing, while negative values indicate decreasing momentum. When the CMO is zero, there is no momentum present.
Divergences between the CMO and the security’s price are often used by traders to identify potential trend reversals. For example, a higher trending price with a downward trending CMO may indicate an impending reversal. Another way to use the CMO is to look for crossovers with its moving average; a crossover above the moving average is typically seen as a bullish signal, while a crossover below it is bearish.
It’s important to note that while the CMO is useful, it should not be the sole basis for trading decisions. Other factors such as market trends, news events, and broader economic conditions should be considered as well. Technical analysis indicators should always be used in conjunction with other forms of analysis.
Tushar Chande’s suggestions on how to use the Chande Momentum Oscillator
Tushar Chande, the creator of the Chande Momentum Oscillator (CMO), has written considerably on the CMO and has offered guidance on how traders can utilize the indicator to their advantage. Here are some of his recommendations:
Confirm trend direction
The CMO can confirm the direction of a trend. A rising CMO can indicate an uptrend, while a falling CMO can indicate a downtrend. The CMO crossing above or below its signal line may provide a potential signal of a trend change.
Identify overbought and oversold conditions
The CMO can identify when a security or asset is overbought or oversold, providing potential trading opportunities. Extreme CMO levels, such as above +50 or below -50, may indicate that the security is due for a reversal.
Look for divergences
Divergences between the CMO and the price of the security can be used as a signal of a potential trend reversal. For example, if the price of a security is trending higher while the CMO is trending lower, it may suggest that momentum is slowing down and a reversal may be imminent.
Combine the CMO with other indicators
Chande suggests using the CMO with other indicators, such as Moving Averages or the Relative Strength Index (RSI), to confirm trading signals and reduce the chance of false signals.
Customize the CMO to suit your trading style
Chande recommends adjusting the CMO to suit your trading style and the security’s characteristics, including modifying the sensitivity of the indicator or adjusting the time period used to calculate the CMO.
Determine the appropriate time period
The time period used to calculate the CMO should be selected based on the trading strategy and the security being analyzed. A longer time period can provide more reliable signals, while a shorter time period can provide more frequent signals.
Consider other factors and avoid using the CMO in isolation
Chande emphasizes that traders should not use the CMO in isolation but as part of a comprehensive trading strategy that takes into account multiple factors, such as market trends, news events, and broader economic conditions.
Manage risk
Traders should manage risk when using the CMO. Stop-loss orders can limit potential losses, take-profit orders can lock in gains, and position sizing strategies can limit risk. Avoid over-leveraging or risking too much capital on a single trade.
In summary, the CMO can identify momentum and potential trading opportunities, but it should be used in conjunction with other indicators and factors. Traders should exercise caution and discipline, manage risk, and consider multiple factors before making trading decisions.
Advantages & Limitations of the Chande Momentum Oscillator
Here are some advantages and limitations of using the Chande Momentum Oscillator in trading:
Advantages
- Identifies momentum: The Chande Momentum Oscillator is a useful tool for traders to detect momentum and identify potential price trends.
- Signals overbought/oversold levels: Traders can use the CMO to identify overbought or oversold levels and take advantage of potential trading opportunities.
- Customizable: The CMO can be tailored to different trading styles and the characteristics of securities, enabling traders to adjust the indicator according to their specific needs.
Limitations
- False signals: The CMO may occasionally produce false signals, as with all technical indicators. As a result, traders may incur losses.
- Influenced by sudden price movements: The CMO can be affected by sudden price movements, which may result in incorrect signals.
- Must be used with other indicators: The CMO is not intended to be used in isolation, but rather in conjunction with other technical indicators and fundamental analysis to create a comprehensive trading strategy.
- Not suitable for all market conditions: As the CMO is designed to identify momentum, it may not perform well in range-bound or choppy markets. Traders should assess current market conditions before utilizing the CMO.
The CMO is a technical tool that gauges a security’s momentum by comparing the current price to the average price over a specific time period. This indicator can provide insights into potential trend reversals and overbought/oversold conditions. To suit diverse trading styles, the CMO can be tailored accordingly and employed in tandem with other technical indicators to formulate a well-rounded trading approach.
While the CMO can assist traders in identifying momentum and potential trading opportunities, it is vital to understand that no technical indicator can offer flawless signals or ensure profits. Therefore, traders must exercise prudence and integrate the CMO into a comprehensive trading strategy that takes into account various factors such as market trends, news events, and economic conditions. It is essential to note that trading always carries risks, and traders must be ready to manage risk and limit potential losses.
For examples of customizable Chande Momentum Oscillator (CMO) factory scans that can be edited, modified, or revised, and subsequently scanned through ChartAlert’s native stock screener or technical analysis scanner, click here.