Technical analysis II

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18. The momentum oscillator

An 'oscillator' is similar to an indicator but is 'normalised'. This simply means that all values are changed by an arithmetical process so that they fall between +1 and -1. Suppose we want to convert Momentum Indicator figures into Momentum Oscillator figures:

Step 1. Decide on the time frame over which you want to produce the chart - let's say, one year.

Step 2. Calculate the momentum indicator for the share in question for that year.

Step 3. Look through the MI figures and find the maximum and minimum indicator figures (i.e. the highest and lowest amount that the share moved).

Step 4. Divide all your MI figures by the larger of the maximum or minimum.

Look at the MI figures below and you will see that the largest figure is +7. In the right-hand column, each of the MI figures has been divided by 7 to produce the MO figures.

You then plot the MO figures on a chart. Simple!

You might be wondering at this point what advantage the oscillator chart provides over the indicator chart. The answer is that with an indicator you are prompted to buy and sell only when a trend is already underway, and as a consequence you always miss a bit of the profit.

With an oscillator, the buy and sell prompts come earlier, sometimes before the trend has started. Look at the chart below and you will see how the MO oscillates between -1 and 1. Your objective is to sell when the oscillator is near 1 and buy when it is near -1. In practice 0.8 and -0.8 will do.

Buying and selling ahead of the market using the momentum oscillator

With such a strategy you may well be going against the short term trend (i.e. buying when the price is still going down, and selling when it is still going up) but the theory is that you will capture all the benefit of a subsequent change of direction.

1. Average share prices 2. Moving averages 3. Weighted moving averages 4. Where to plot moving averages 5. Interpreting moving averages - the basics 6. Classic interpretation of moving averages 7. Combining short and long term moving averages 8. Moving average convergence/divergence (MACD) 9. Reversal patterns 10. Head and shoulders top 11. Head and shoulders bottom 12. Double top 13. Double bottom 14. Rounding tops and bottoms 15. Broadening formations 16. Wedge formations 17. The momentum indicator 18. The momentum oscillator 19. Rate of change indicator 20. Price minus average 21. Relative strength indicator 22. Conclusion

• Martin Pring's Introduction to Technical Analysis
• Technical Analysis Plain and Simple
• Technical Analysis of the Financial Markets