Ch7. Oscillators and Momentum Indicators

What Is an Oscillator?

An oscillator is an indicator that fluctuates within a defined range, designed to capture the strength of a price trend and identify potential turning points.

Core uses:
→ Identify overbought / oversold zones
→ Spot divergence → trend reversal signals
→ Measure trend strength

RSI (Relative Strength Index) — Deep Dive

RSI = 100 - [100 ÷ (1 + RS)]
RS = Average gain ÷ Average loss (default: 14 periods)

Interpretation:
Above 70: Overbought → possible sell signal
Below 30: Oversold → possible buy signal
50 level: Confirms trend direction

Practical tips:
→ RSI above 70 in a strong uptrend ≠ automatic sell
→ Trending markets: RSI can stay elevated in the 30–70 range
→ The 30/70 levels are most effective in ranging (sideways) markets

RSI Divergence

Bullish Divergence (buy signal):
Price: lower lows ↓ / RSI: higher lows ↑
→ Price falling but RSI rising = weakening downward momentum

Bearish Divergence (sell signal):
Price: higher highs ↑ / RSI: lower highs ↓
→ Price rising but RSI falling = weakening upward momentum

Stochastic Oscillator — Deep Dive

%K = (Close - Period Low) ÷ (Period High - Period Low) × 100
%D = 3-period moving average of %K

Fast Stochastic: %K (sensitive)
Slow Stochastic: uses 3-period MA of %K as new %K (recommended)

Buy signal: %K crosses above %D below the 20 level
Sell signal: %K crosses below %D above the 80 level

MACD (Moving Average Convergence Divergence) — Deep Dive

MACD Line = 12-period EMA - 26-period EMA
Signal Line = 9-period EMA of MACD
Histogram = MACD - Signal

Signals:
Golden Cross: MACD crosses above Signal → Buy
Death Cross: MACD crosses below Signal → Sell
Histogram zero-line crossover: trend reversal signal

MACD Divergence:
→ Same principle as RSI divergence — especially powerful on higher timeframe charts

CCI (Commodity Channel Index)

CCI = (Typical Price - Moving Average) ÷ (0.015 × Mean Deviation)

Typical Price = (High + Low + Close) ÷ 3

Interpretation:
Above +100: Overbought / Below -100: Oversold
Zero-line crossover: trend reversal signal

Characteristics:
→ More effective on commodities and crypto than equities
→ Fast reaction time (good for short-term signals)

Multi-Oscillator Strategy

Confirmation Strategy:
RSI + Stochastic both oversold simultaneously → Strong buy signal
→ Higher reliability than a single indicator signal

Divergence Confirmation:
RSI + MACD divergence at the same time → Significantly higher probability of trend reversal

Caution:
→ Never trade on oscillators alone
→ Always combine with trend indicators (moving averages, Bollinger Bands)

RSI Divergence: Price ↓ + RSI ↑ = bullish reversal signal (highest reliability) Stochastic: %K crossing %D below 20 / above 80 = buy / sell MACD Histogram expanding = trend strengthening, contracting = trend weakening Never use oscillators in isolation — always pair with trend indicators