Momentum Indicators and their Value

Momentum represents the acceleration of price movement. The trader can use it to understand the velocity of price change and whether a trend is strong or nearing exhaustion. As a race car fan, and with the Formula one season about to start, we can use a car’s acceleration as a proxy for momentum.

Imagine a car accelerating onto a highway. It will get faster quickly at first, from 10-20, 20-30, 30-40mph. The rate of change is the same. But as you approach the highway speed limit the car will continue to get faster but at a slower rate. The car will get faster more slowly! From 40-45, 45-48, 48-50. At the speed limit (50mph in New Jersey) you are likely to stop accelerating or risk the long arm of the law! Decreasing acceleration therefore precedes top speed. Most likely, we will then eventually slow down to exit.

So it is with price momentum. If price makes a higher high, we would like to see it maintain momentum. If price climbs but momentum wanes, it is like the car accelerating more slowly! We may be reaching top speed and further price gains may be difficult to achieve and we may even see a pull back. The first chart is a chart displaying weekly SPY prices with some popular momentum indicators applied. ROC, CCI, and RSI.

Powerful Concepts

Remember, momentum indicators measure the velocity of price movement. If market enthusiasm drives price quickly in one direction it can become overbought, or oversold. At these extremes, a technician may expect price to revert to its mean in the short term. Using RSI as an example with SPY prices, we note that when the oscillator moves above 70, it is overbought. When it moves below 30 it is oversold. We have used ellipse annotations to highlight on the chart. Often, following these, price reverts to the trend (red and green arrows).

Oscillator divergence is another important momentum concept. If we think back to our accelerating car, when it is getting faster but at a slower rate, that is divergence. When price makes a higher high but momentum makes a lower high we know that price is climbing but with less enthusiasm. Perhaps price has hit its “top speed”. Again, using the chart above, we can see divergence highlighted with blue arrows. Currently, price is making slightly higher highs while RSI is making lower highs. Is price about to struggle in the near future?

Analysis Paralysis and the GoNoGo Oscillator

Yesterday, we saw that when we added trend identification concepts to our chart we risked missing the bigger picture due to analysis paralysis. Imagine adding 3 or 4 momentum indicators to that same chart! Our chart would be hard to read and our judgement clouded. We know there is value in this analysis but we risk redundancy and even contradiction as we add more.

In this last chart, we have weekly SPY prices with the GoNoGo Oscillator applied. From working for decades with professional technicians we know that we need insight without indecision! GoNoGo Oscillator takes the same approach as GoNoGo Trend. In the background, the oscillator calculates several of the most robust momentum tools and blends them into one oscillator that can be added to our chart. We can identify areas of overbought and oversold extremes (ellipses), and easily pick out divergence from price (grey arrows). Adding the GoNoGo Oscillator we have a sound understanding of momentum analysis, and keeping it all in only one panel makes sure we focus on simplicity and remove complication.

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