6 Momentum and Oscillators

The study of momentum and oscillators is an analjsis of price changes rather than price levels. Among technicians, momentum establishes the speed of price movemerit and the rate of ascent or descent. Analjsts use momentum interchangeably with slope, a straight-line angle of inclination of price movement as measured from a horizontal line representing time. Momentum is also thought of as force or impact; it is often considered, as in Newtons Law, that once started prices tend to remain in motion in a somewhat straight line.

Rate-of-change indicators, such as momentum and oscillatcrs, are used as leading indicators of price change. They can identifj when the current trend is no longer maintaining its same level of strength. This gives the frader an opportunity to begin liquidating the open-trend trades before prices actually reverse. As the time period for the momentum calculation shortens, this technique of leading a frend changes to become more aggressive and is interpreted as a countertrend method. Use of a rate-of-change indicator anticipates change even sooner.

Before beginning a discussion of various momentum calculations, a brief comment on terminologj will be helpful to understand how various techniques are grouped together. We begin with a single price, which has no movement. When we talk about bonds at 110 or gold at $400 per ounce, we are relating a price level and not impljing that prices are going up or down. Next we describe the speed at which prices are rising or falling. It is not enough to say that the S&P rose 3 points-- rather, you must specify, the time interval over which this happened-TheS&P rose 3 points in one hour.-When you say that you drove your car at 60, you really imply that you were going 60 miles pei hour, or 60 kilometers per hour. This description of speed, or distance covered over time, is the same information thai is given by a single momentum value

The last measure is one of change in speed, which is either acceleration or deceleration The price of the Deutschemark may have risen by .0150 dollars per mark in the past week, indicating an average speed of .0150/5, or a rise of .0030 dollars mark per day however, it started rising slowly and increasing its speed over the week. Perhaps the marie rose .0010 on Monday, .0020 on Tuesday, .0030 on Wednesday, .0040 on Thursday, and .0050 on Friday, increasing in speed (or accelerating) by.0010 each day. The term rate of change (ROC) will also he used to describe acceleration; when the rate of change is zero, we are talking about speed and momentum.

You will see in this chapter that speed is a more sensitive measurement than price level, and acceleration is more sensitive than speed. The various techniques described here are presented in order of speed and then rate of change. Following that is divergence, the most popular use of momentum indicators.

MOMENTUM

Momentum is the difference between two prices taken over a fixed interval. It is another word for speed, the distance covered over time. For example, todays 5-day, momentum value M would be the difference between todays price P, and the price 5 dajs ago:

(5-clay) M = r,-P, Using notation familiar to many prcjgrarnmers;

momentum = price - price[5] or

n = price - priceCND

where the notation N refers to the (closing) price N days ago.

The m mentum valu M in as the change in price ncrea.se.s over the 5-da> period. Figure 6-1 hows that m mennim s also related to slope; that is, a faster price increase will cause both angl a to become larger and the hypotenuse of the triangle, marked "momentum to increase Ifthe5-da momentum is 100 the slope of the momentum line can be expressed as 100/5 = 20 If prices had increased by t 0 points over the same time interval, the slope would be 150 5 30 and the mom ntum would be 150.

The 5-day momentum At can range in value from maximum upward move to the maximum downward move that the price can make in d ih mom nt m is zero if prices are un hanged afte 5 days Figure 6-2 shows th possible moves in th m m .ntum calculation onside a commodity with a 20-point daily limit. Starting al point the 5-day price change it reas d at a faster rate for 8 days (up 2, up 4, etc.) until at point prices were moving a thei tast st 5-d ly rate. At point the 5-day price change wa.s three-fifths of the maximum IDO-point ch nge or 60 points. From point to poiru prices still ncteased, but at a slower rate until the 5-day difference at point was zero Prices then declined at an increasing rate until at point D th maximum $-da dedin of 40 points wa.*; reached; at point E the 5-da difference was agai- zero Note that at po nt prices did not start down but only increased at a slower rate, only at did prices first begin their 5-day decline.

Momentum as a Percentage

Momentum, as most other calculations, can be expressed as a percentage rather than a raw value of its components. This is usually done by dividing the current value by the previous price or index level, so that a 5-day momentum maybe

FIGURE 6-i Geometric representation of momentum.

FIGURE 6-2 Momentum range.

The difference in the two approaches is limited by the percentage change in the underly ing price over the 4-day period between t - 1 and t - 5. It is not likely that the change will even be noticeable on a chart of "oM, and it is best to standardize the approach to taking percentages using t -1

Price and Trend Difference

it IS common for the temi momentum to refer to the difference between todays price and a corresponding moving average value. The properties of this new value remain the same. As the momentum becomes larger, prices are moving away from the moving average at a faster rate. When it gets smaller, the prices are converging with the moving average. Unlike the first definition of momentum, a value that is positive but converging toward the moving average may actually represent declining prices rather than prices that are advancing at a slower rate. The ma}or similarity is that the peak of the price move is near the extreme points of the momentum chart.

Figure 6-3a (upper panel) shows 10-period and 40-period moving averages plotted on a 15-minute German bund chart. Figure 6-3b (center panel) shows the difference between the price and the 40period moving average; the momentum value is fairly uniform, varjing by about .50 above and below zero. Because the moving average tends to catdi up to prices over time, the maximum variation of the momentum measured this way is not as exfreme as when momentum is calculated as the difference between two prices. This momentum calculation has also been called relative strength, because it is measured relative to a moving average.

Moving Average ConvergencelDivergence (MACD)

Momentum may also be seen as the difference between two moving averages, a technique developed by Gerald Appel and named the Moving Average ConvergencelDivergence (MACD). In its original form, the two trendlines were produced using exponential smoothing, and their difference resulted in the MACD value. This was fiirther smoothed to give a sign line. The most common presentation of MACD uses the difference between a 12-day and 26-day exponential smoothing. The signal line, used to produce frading rec

Tr. iu J. .1 D Becker, "Value i oscillat. in .letenuiiiiu? price action," Futures Isy 1 4)

FIGURE6-3 Momentum as relative strength, the difference between prices and a moving average, or between two moving averages (MACD). (a, top panel) 1 0-day and 40-day moving averages plotted with 1 5-minute German bund prices, (b, center panel) Momentum as the difference between prices and the 40-day moving average, (c, bottom panel) MACD as the difference between the 1 O-day and 40-dav moving average values.

Souro!. Chan created wiih TrnfeSlatkin* by Onwga Researdi, Inc

ommendations, is a 9-day smoothing of todays MACD subtracted from todays MACD. in programming code, the function taSmoothedAverage refers to an exponential smoothing:

MACD = @SnioothedAverage(c1ose,12) - @SnioothedAverage(close,26) signdl line = MACD - @SnioothedAverage(MACD,9)

The basic rules for frading the MACD would enter trend positions by referring only to the signal line calculation. Buy when the signal line moves above zero, and sell when the signal line falls below zero. Many fraders, however, prefer to use the combination of MACD and signal line for signals, bujing when the signal line crosses above