Oscillators and Momentum Indicators

What is an Oscillator and its Purpose

• Oscillators are momentum indicators used in
technical analysis, whose fluctuations are bounded
by some upper and lower band.
• When oscillator values approach these bands, they
provide overbought or oversold signals to traders.
• The primary purpose of oscillators is to help traders
decide when it might be a good time to buy or sell.
• When to Use?
o It is most useful when a stock is trading
sideways or horizontally, or when there's no
clear trend.

What is a Momentum Indicator and its Purpose Relative Strength Index Failure Swings
• is a technical analysis tool used to determine the • Failure Swings
strength and weakness of a stock’s price trend. It o Failure swings are another occurrence
shows the rate of change in price movement over a which Wilder believed increased the
period of time, helping investors assess the strength likelihood of a price reversal. One thing to
of a trend and spot potential shifts or reversals. keep in mind about failure swings is that
• Key Takeaways for Momentum Indicator they are completely independent of price
o Measures Speed and rely solely on RSI.
o Trend Strength o Bullish Failure Swing/ Bullish Swing
• When to Use? Rejection
o Momentum indicators are used to identify 1. RSI drops below 30 (considered
trends and potential turning points in stock oversold).
prices. 2. RSI bounces back above 30.2.
3. RSI pulls back but remains above
Relative Strength Index (RSI) as a Momentum Indicator for 30 (remains above oversold)
Detecting Trend Reversals 4. RSI breaks out above its previous
• Key momentum indicator in technical analysis used high.
to detect potential trend reversal points in the price Example:
of an asset.
• RSI operates between a scale of 0 and 100.
• Traders use RSI to generate buy or sell signals,
confirm potential trend reversals, and identify
market divergences.

Overbought Condition - RSI value above 70

typically suggests that an asset is overbought.

Oversold Condition: An RSI value below 30 suggests that an

asset is oversold. o Bearish Failure Swing / Bearish swing
rejection
Relative Strength Index Divergence Trading Strategy. 1. RSI rises above 70 (considered
• Divergence Trading Strategy overbought)
o RSI Divergence occurs when there is a 2. RSI drops back below 70
difference between what the price action is 3. RSI rises slightly but remains below
indicating and what RSI is indicating. 70 (remains below overbought)
o Bullish RSI Divergence – occurs when the 4. RSI drops lower than its previous
price of an asset is making lower lows, but low.
the RSI is making higher lows. Example:
Bearish RSI Divergence – When price makes
a new high but RSI makes a lower high.
Example:
 • Negative Reversals
o In negative reversal, the RSI indicator forms
higher highs, but the price chart forms
lower highs.

o
• Positive and Negative Reversals can be boiled down
to cases where price outperformed momentum. And
because Positive and Negative Reversals only occur
in their specified trends, they can be used as yet
another tool for trend confirmation.

Formula for RSI is

Example of both.

• RS = Average Gains/ Average Lossess

1. Determine the Price Change
2. Separate the gains and losses
3. Calculate the average gain and average loss over
the 14-day period
o Average Gain = (2 + 3 + 2 + 1 + 2 + 1 + 3
+ 1) / 14 = 15 / 14 ≈ 1.07
o Average Loss = (1 + 1 + 3 + 2 + 4) / 14 =
11 / 14 ≈ 0.79
4. Calculate the Relative Strength (RS)
o RS = Average Gain / Average Loss =
1.07/0.79 = 1.35
5. Calculate the RSI
o 100-100/(1+1.35) = 57.45

Relative Strength Index Positive and Negative Reversals

• Cardwell’s Positive and Negative Reversals
o Differ from regular divergence patterns.
Unlike traditional RSI divergences, which
often signal potential trend reversals,
Cardwell’s reversals indicate trend
continuations.
• Positive Reversals
o In positive reversal, the RSI indicator forms The Relative Strength Index (RSI):
lower lows, while the price chart forms Identifying Overbought and
higher lows. Oversold Conditions

o
Moving Average Convergence/Divergence (MACD) 2. Signal Line: This is a 9-period EMA of the MACD line.
• A momentum oscillator used to identify the changes It’s used to smooth out the MACD line and
of speed and direction of price movement. generate buy/sell signals.
o POSITIVE = line above zero • Signal Line= EMA(9) of the MACD Line
o NEGATIVE = line below zero 3. Histogram: This represents the difference between
the MACD line and the Signal line. It’s visually shown
How MACD measures momentum as bars above or below the zero line.
1. Convergence and Divergence • Histogram=MACD Line−Signal Line
• Convergence Example:
i. When 12 and 26 EMA come closer
together it indicates a
weakening momentum or a
potential trend reversal.
• Divergence
i. when MACD line moves in opposite
direction between price and
momentum signaling a potential
reversal.

The Commodity Channel Index (CCI):

Identifying Overbought and Oversold Conditions

Stochastic Oscillator
• A momentum indicator that is similar to RSI that
indicates overbought and oversold.
• They consist of 2 lines which are %K and %D
2. Histogram
• A chart that plots the area between MACD 2 Types of Stochastic Oscillator
line and signal line, visually represents the • Fast Stochastic Oscillator
strength of the momentum. • Slow Stochastic Oscillator
• Taller bars indicate stronger momentum, Formulas:
while shorter bars suggest weaker
momentum.
Example:

• %D = average of %K (over D periods)

• D = 3 (default)

3 ways of using Stochastic Oscillator

Components of MACD:
1. MACD Line: This is the difference between two • Overbought and Oversold Conditions
exponential moving averages (EMAs) — typically, the
12-period EMA and the 26-period EMA.
• MACD Line=EMA(12)−EMA(26)
 o A reading above 80% suggests that the
security is overbought, and a potential price Formula of CCI
reversal to the downside may occur.
o A reading below 20% suggests that the
security is oversold, and a potential price
reversal to the upside may occur.
• Crossovers
o %K crosses below %D (Sell Signal)
o % K crosses above %D (Buy Signal)
• Divergence
o if price is upward trend while Stochastic is
Downward = Bearish reversal Step 1.
o if price is downard trend while stochastic is
upward =bullish reversal

The Stochastic Oscillator: Identifying

Overbought and Oversold Conditions.

Step 2.

Commodity Channel Index

• A momentum based oscillator that determines
Overbought and Oversold in a market.

Overbought
• Above +100
• Potential sell signal
Oversold
• Below -100
• Potential buy signal
Neutral Step 3.
• Between above 100 and below 100

Commodity Channel Index Divergence

• Bullish Divergence = Price going down, but CCI going
up
• Bearish Divergence = Price going up, but CCI going
down
Example:

Step 4.
 • Technical analysis relies on statistical
probabilities, meaning some trades will
inevitably result in losses.

Risk-Reward Ratio
• The risk-reward ratio or also known as the
Oscillators of Moving Average risk-return ratio. Investors use risk-reward
• The OsMA is a technical indicator that shows the ratios to compare the expecte returns of an
difference between an oscillator and its moving investment with the amount of risk they
average over a given period of time. must undertake to earn these returns.
• The OsMA is a combination of an oscillator and a
moving average of that oscillator. It measures the Position Sizing
distance between these two values. • Position sizing refers to the number of units
• The OsMA is a useful indicator of trend and trend invested in a particular security by an
strength investor or trader.
• The MACD is the most common oscillator used in the
OsMA indicator, although any oscillator can be used. Factors Affecting Position Sizing:
• Account Risk/Risk per Trade
Oscillators of Volume o “This typically gets expressed as a
Analysis With the use MACD percentage of the investor’s
and OBV Indicator capital. As a rule of thumb, most
The Volume Oscillator displays the difference between two retail investors risk no more than
moving averages of a security's volume expressed as a 2% of their investment capital on
percentage. You can use the difference between any one trade.”
two moving averages of volume to determine if the • Trade Risk
overall volume trend is increasing or decreasing . o The investor must then determine
• The Moving Average Convergence/Divergence where to place their
indicator is a momentum oscillator primarily used to stop-loss order for the specific
trade trends. Although it is an oscillator, it is not trade.
typically used to identify over bought or oversold • Proper Position Size
conditions. It appears on the chart as two lines which o To work out the correct position
oscillate without boundaries. size from this information,the
• The on balance volume (OBV) indicator is a technical investor simply needs to divide the
analysis tool used to detect market sentiment based account risk by the trade risk.
on an asset's trading volume over time
Stop-loss and Take-profit Strategies
Module 8: Risk Management and Trading Strategies • Stop-loss Orders
o It is an order with a broker to buy or sell
What is Risk Management? a stock when it reaches a specific price.
In technical analysis, risk management refers to the strategies o Stop-loss prevents you from losing too
and practices traders and investors use to minimize potential much of your investment.
losses and optimize their trading performance. It is a crucial • Take-profit Orders
aspect of trading, as it ensures that risk exposure is controlled o It is a type of limit orderthat indicates the
and capital is preserved, even in volatile market conditions. precise price at which to exit an
open trade for a profit. The take-profit order
Why does it matter? is not filled if the security's
1. Protect Capital price falls below the limit price.
• Markets are inherently unpredictable, and o Take profit helps you to lock-in what you’ve
even the most reliable technical patterns already earned.
can fail. • Trailing Stop-loss
2. Limits Emotional Decision-Making o Trailing Stop is an automatic order type
• Without a solid risk management plan, fear that locks in profits and limits losses when
and greed can lead to impulsive actions, the trade goes favorably.
such as holding losing trades too long or Example:
exiting winning trades prematurely.
3. Ensures Long-Term Survival
 you protect gains while allowing theposition
to potentially continue its trend.
• Set Profit Targets
o Have predefined profit targets based on
technical analysis, key support/resistance
levels, or risk/reward ratios. This helps avoid
greed and ensures you're not overly
attached to the trade outcome.
• Scale Out of Positions
o If you're confident in a trade but don't want
to risk losing all of your profits, consider
scalingout. Close a portion of your position
when you're in profit, and let the remainder
Common Trading Strategies run with atrailing stop or new profit target.
• Trend-Following Strategies
o Follows the momentum of a trend Diversification
o Buys in an uptrend • Is an investment strategy that involves spreading
o Sells in a downtrend your investments across different assets, sectors, or
o Moving Averages geographic regions to reduce risk. While
• Breakout Strategies diversification doesn't guarantee profits or prevent
o Occurs when prices above or below a losses, it can help smooth out the volatility in a
resistance or support level portfolio.
o Channels, Triangles, and Flags
• Reversal Strategies
o Goes against the prevailing trend
o Looks for signals that a trend is losing
momentum
o Candlestick patterns, Oscillators such as RSI
and MACD
• Range-Bound Strategies
o Aims to gain profit from price fluctuations
o Buys near support levels
o Sells near resistance levels

Managing Losing Trades

• Set a Stop Loss Order
o Always use a stop- loss order to limit
potential losses. This ensures that you
automatically exit a position if the market
moves against you beyond a
predetermined point.
• Adhere to Risk Management
o Determine how much ofyour total capital
you're willing to risk on each trade
(commonly 1-2%) and stick to it. This helps
prevent large losses from wiping out your
account.
• Avoid Emotional Trading
o When facing a losing trade, emotions like
fear or anger can cloud judgment. Stay
calm, stick to your trading plan, and resist
the urge to revenge trade.

Managing Winning Trades

• Trail Your Stop Loss
o As your trade moves in your favor, adjust
your stop-loss to lock in profits. A trailing
stop moves with the market, ensuring that