Chart Advisor: Finding Top Speed

By Alex Cole

1/ Momentum and How it’s Useful

2/ Calculation and Indicators

3/ Powerful Concepts

4/ Analysis Paralysis

5/ GoNoGo Oscillator

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1/ Momentum and How it’s Useful

To the technician, momentum represents the acceleration of price movement. It can help the trader understand the velocity of price change and give clues as to whether price will continue in the current direction or if a trend is at risk of stalling.

When teaching momentum to new technicians, I often talk about cars.  I grew up in a strong car culture where Formula One had us glued to the TV. Using a car’s acceleration as a proxy for price momentum resonates with students and demonstrates the value in studying these indicators.

Imagine a car accelerating to join a highway. The car will accelerate quickly at first, from 10-20, 20-30, 30-40mph. The rate of change of speed is the same. But, as you approach the highway speed limit you will continue to get faster but at a slower rate. You were getting faster more slowly!  And at 50mph (the speed limit in NJ) you are likely to stop accelerating or risk the long arm of the law! Decreasing acceleration alerts us to the fact that we are approaching top speed.  Our next move is likely to slow down when we approach our exit.

So it is with price momentum. With each price increase, we would like to see the same momentum.  If price makes a higher high, we would expect similar or higher highs in momentum when a trend is strong.  If price climbs higher but momentum wanes, it suggests we are approaching top speed!  There is a chance we will not see further price gains and even the chance that price may fall.

Below is a chart with a new momentum oscillator, the GoNoGo Oscillator applied. 

2/ Calculation and Indicators

Momentum indicators measure how quickly price has arrived at its current level. They will typically involve a look back period to compare the current price with prior prices in some way.  We will take a quick look at some of the most popular.

Rate of Change (ROC) – first oscillator panel.

This indicator is one of the simplest ways to get a sense of the speed of price change.  The calculation is simply (current price – price N bars ago) / price N bars ago. 

In this way it makes the change a percentage and so gives a reading that can be compared across securities. 

Commodity Channel Index (CCI) – second oscillator panel.

The CCI is another popular and much used oscillator. It is different from ROC in that it looks at price and compares it to an average of its prices over a look back period. Remember, ROC used a single historical price.  In layman’s terms, CCI compares price to an historical average of price, and then divides by a standard deviation of price.  The price used is the “typical price” or (H + L + C) / 3.

Relative Strength Index (RSI) – final oscillator panel.

Perhaps the most used momentum industry in our industry, RSI has yet another calculation. RSI looks back over a set number of periods and evaluates whether the bar closed up or down.  Then, it divides the number of up closes by down closes and converts this idea into a bounded oscillator that moves between 0-100. The concept has value because we would expect that as prices move higher there will be more higher closes relative to lower closes.

3/ Powerful Concepts

Remember, momentum indicators measure the velocity of price movement.  If an asset has moved too quickly in one direction it can move away from its real value.  Technicians describe these conditions as overbought or oversold. At these extremes a trader may expect pride to mean revert in the short term.  If we use RSI as an example, we have highlighted areas of overbought and oversold on the chart below with arrows.  When the indicator crosses into overbought territory (above 70, white arrow) we consider price overbought.  When it crosses back below 70, we might expect price to move lower in the short term due to the waning momentum (blue arrow).  Later in the chart we have highlighted a situation where the RSI moves from oversold back to neutral (green arrow).

Oscillator divergence from price is another important concept.  Think back to our car accelerating, getting quicker but more slowly!  That is the concept of divergence.  When price makes a higher high but momentum makes a lower high we know that there is less enthusiasm behind this latest higher high. Perhaps our security has hit its top speed and we will look for it to move lower in the short term.  Again, see the chart using RSI as an example. Bearish divergence has been highlighted with dashed trendlines.

4/ Analysis Paralysis

In yesterday’s article, we saw how adding indicators and concepts to our chart could cloud our judgment and leave us more confused than when we started. The same can happen here.  We know there is value in analyzing these oscillators.  Each of these studies attack the problem of momentum differently and each bring something new to our process. But, if we add these studies to our price chart we can see how quickly we can complicate our research.

Not only do we make our chart hard to read, we risk introducing redundancy and contradictory information.  For example, look closely at the three oscillator panels toward the right of the chart.  See if you can spot that while ROC is showing bullish divergence, the other two (RSI and CCI) are not.  What should you believe?

5/ GoNoGo Oscillator

In this last chart, let’s return to the GoNoGo Oscillator we saw at the beginning.  Years of working with professional technicians has taught us that having the information from momentum indicators is extremely valuable.  Therefore, we need to ensure we have the insight but without the indecision.  With GoNoGo Oscillator the same approach was taken as with GoNoGo Trend.  In the background, GoNoGo Oscillator calculates several of the most robust momentum concepts into one oscillator that can be added to our chart.  This allows us to still use momentum to inform our understanding of price activity.  We can identify areas of overbought and oversold extremes (red and green arrows are examples). We can also quickly see divergences (bullish and bearish examples highlighted by dashed trendlines). Adding the GoNoGo Oscillator to our chart we get a sound understanding of momentum analysis. Keeping it all in only one extra panel makes sure we focus on simplicity and remove complication.  We now have an understanding of trend and momentum in an easy to read chart.

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Originally posted 14th November 2023