Indicators used to help traders & investors understand the strength of price trend by measuring the rate of change. Momentum is calculated over a set parameter of previous chart history which is why it is a lagging indicator. Momentum can be a very effective tool that has many uses such as identifying trend continuations or reversals.
The most popular momentum indicator is "Relative Strength Index" or "RSI". Other popular momentum indicators include MACD, Stochastics, Price Oscillators, Moving Averages, CCI, MOM, ADX, and more.
For now, I will cover my favorite and most used momentum indicators needed to understand the Elliott Wave Theory learning section. The indicators currently included in this section are Relative Strength Index (RSI), Moving Averages, Stochastic RSI, and Price Oscillator. We will deep dive what each indictor does, represents, and its uses. There will also be information on how to tweak each indicator to your preference along with how I have them set. In the future I will cover more indicators I use such as Volume Profile, MACD, and many more.
Relative Strength Index (AKA "RSI") measures the speed of price changes and rates this strength between 0-100.
Traders and investors use RSI to help determine and identify trend strength for potential continuations or reversals along with extreme areas to expose entry and exit opportunities. The RSI indicator by default displays a smooth line moving between 0-100. In the simplest terms, when RSI>70 the (time/price)frame may be considered overbought and in reverse, RSI<30 would generally be considered oversold. However simple as that sounds, reading stock charts is not always a simple task. RSI is a powerful tool when used together with other metrics such as Moving Averages and/or EWT as examples. RSI (like anything that has system defaults) can be tweaked in many different ways. If a trader or investor know what they're looking for, then altering settings or being creative can offer great insight. Under the right settings, RSI can be very reliable for exposing divergences between momentum and price. This is another reason why RSI is a important tool. Lets look at a few ways to enhance RSI.
The settings for RSI can take a basic indicator and turn it into gold. The 3 images on the right show a basic RSI indicator, final adjustments, & updated RSI using short and long length RSI to expose the true areas of opportunity. I prefer to set Price to (O+H+L+C)/4 to broaden the range & the Average Type set to "Wilders" which is slower to respond to price than "simple" or "exponential" to ensure solid confirmations.
Note how long RSI remained overbought in the default settings Image above highlighted in a large red box. Then note how when using the customized RSI in the image below showed the exact area when to sell or exit longs. That is because (IMO) true RSI overbought/oversold values should be set to 83/17, not 70/30. Additionally, one length for RSI is not enough. By default, systems set RSI to 14 period Length. I prefer to layer two RSI indicators, one with a 15 period (long) length and the other with a 3 period (short) length. This puts a spotlight on divergences not only between momentum and price but between short and long periods. RSI with customizations will almost always produce clearer and more accurate signals.
Moving Averages calculates the price over a set period of time and displays a smooth line on the chart indicating the average price over that set period of time.
The Moving Averages stock indicator is one of the most widely used indicators in technical analysis. Technical analysis using moving averages usually incorporates a combination of averages used over a range of history based on the time/price-frame. For example, analysts will include 20, 50, & 200 period moving average for a daily chart study to show data that includes 3 average prices of the previous 20, 50, & 200 daily sessions. The number of periods should relate to the frame, meaning a 200 period daily average may have more meaningful near term impact than a 200 period monthly average whereas a 10 period monthly average may be more significant than a 10 period daily average. Analysts look at the interactions between different length MAs across frames along with their respective levels for exposing buy or sell opportunities. MAs can offer insight on trend strength, support or resistance levels, continuations, and reversals. Because moving averages is a lagging indicator (shows avg of previous prices) traders and investors will use MAs along with other indicators like Momentum and leading indicators such as sector divergences, company fundamentals, and Elliott Wave Theory to confirm their thesis. Generally it is bullish when price is trading above all MAs while shorter MAs are moving above the longer MAs. Generally, it is bearish under reverse conditions or when longer MAs fail during an uptrend.
The images below illustrates 3 different ways that moving averages can be used. The first image demonstrates a bullish "Golden Cross" which is an example trade to look for a buy opportunity once the 50 MA crosses above the 200 MA. A bearish "Death Cross" is the opposite moving average cross. Generally speaking, the signals are stronger and more reliable the longer the time/price frame. The second image illustrates one key component for a "Cup & Handle" stock pattern which is that the 50 MA should be moving through the middle of the cup. Cup and handles target 100% the length of the Cup from Handle and offered amazing returns for traders who bought the MA200 or even the MA50 support. The third example is an intraday chart showing trade opportunities from longer length MA support found and exit opportunities when shorter length MA support fails and crosses below the longer length MA.
Simple (SMA), Exponential (EMA), & Weighted (WMA), moving averages are just a few examples available in most trading platforms. Traders will most often view SMA which is considered more of a long term average since it is calculated smoothly across the plotted period. MAs such as EMA & WMA are influenced greater by recent price (vs longer price across the plotted period length) and can highlight a more near term perspective of price.Traders generally use a mixed bag of moving averages that cater to their trading style.
Stochastic is a well known oscillator that measures two plots between a specific price over a set period. Highly regarded as a reliable tool, stochastic is very similar to RSI yet has some key differences. RSI measures speed of the rate of price change over a set period of time, whereas Stochastic measures the range of closing price over a set period of time making it more sensitive to fluctuation and print more signals than RSI. Stochastic RSI measures RSI over a set period of time.
Stochastic is widely used in choppy markets due to its price based formula which can be effective during volatile price swings. RSI is known to be more effective in trending markets. Stochastic RSI is a hybrid that can be effective in all markets. Stochastic RSI's most common use is for confirming near/mid term entry and exit areas and reversals. In simple terms, when the two stochastic plot lines cross while overbought or oversold and then exits back into 17-83 would signal for a trade. However, stochastic can stay in overbought/sold zone once it enters or quickly divert and re-enter overbought/sold zones during bullish and bearish cycles. Traders typically look at StochRSI as additional confirmation with other technical analysis. It should not be used alone.
I added a line which separates the first half of the settings that calculates the RSI formula. The second half calculates the stochastic. Since I am looking for near/mid term signals to compliment my other indicators, I have RSI set to a Medium length and stochastic set to shorter lengths.
The Price Oscillator measures the difference between two moving averages over a median of 0. Above 0 is bullish while below 0 is bearish.
General uses for the Price Oscillator are for determining trend strength along with areas of divergence between oscillator and price. My particular use of Price Oscillator is for identifying larger degree cycle pivots on longer timeframes and intraday trend strength for swings on a 4 hour timeframe.
Since I am looking to compliment other indicators by highlighting Major pivots using Price Oscillator, I have it set to simple moving average and mostly longer lengths. I encourage you to explore your favorite indicators settings and compare the differences on the charts to gain more experience and find what works for you.