Momentum indicators, commonly referred to as oscillators, strip away the trend component from the price, spotlighting the cyclical aspect. They are typically leading indicators and are displayed in a distinct panel.
Popular Momentum Indicators
A plethora of oscillators exist, each boasting unique features. The momentum oscillator stands out due to its simplicity; it's calculated by:
Some momentum indicators, like the renowned Moving Average Convergence Divergence (MACD), TRIX, and Awesome Oscillator, employ smoothing techniques. Though they offer clearer insights, they can sometimes lag.
Scale-Neutral Momentum Indicators
Certain momentum indicators are scale-neutral, meaning they maintain a consistent scale, irrespective of the price's original scale. For instance, an oscillator is scale-neutral when:
where k is a positive integer. These oscillators, sometimes termed normalized, have fixed ranges. The Relative Strength Index (RSI) is a prime example of such an indicator.
The Stochastic Oscillator, another scale-neutral tool, comprises a %K line and its smoother counterpart, %D. These scale-neutral indicators' merit is their ability to maintain fixed "overbought" and "oversold" levels, assisting traders in gauging market extremities.
Other notable momentum indicators include the Commodity Channel Index (CCI), True Strength Index (TSI), and William %R.
Detecting Divergences
Traders employ momentum indicators to pinpoint divergences between price and the oscillator. A divergence arises when price and the indicator move in contrasting directions. This discrepancy can be assessed by examining the peaks and troughs created by both the price and the indicator.