Let’s look at the Chande Momentum Oscillator and how we can use it with divergence signals. It can be used to take some great trades. Tushar Chande created it to calculate the price of momentum on bullish days (like the RSI Oscillator). It’s also used to calculate momentum on bearish days as well.
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What Is the Chande Momentum Oscillator?
Tushar Chande developed the Chande Momentum Oscillator (CMO) to calculate price momentum on up days (like the RSI Oscillator). But also to calculate momentum on down days as well. Or we can use it to avoid entering into a trade.
This blog entry is focused on a useful tool for swing traders. If you haven’t read the other Divergence Blogs, you can find the RSI, the MACD, and the On Balance Volume.
The formula is interesting:
1.) If today’s close is higher than yesterday’s close, subtract yesterday’s close from today’s close. CMOa
2.) If today’s close is lower than yesterday’s close, subtract today’s close from yesterday’s close. CMOb
3.) Sum up all the values for the timeframe (I like 13 as the Lookback Period)
4.) CMO= 100 x (CMOa – CMOb) / (CMOa + CMOb)
Typical Chande User Dialog Box
Chande Momentum Oscillator Levels
The picture above shows the typical Chande Momentum Oscillator user dialog box with a look-back length 20. It shows the Chande Momentum Oscillator (CMO), Zero Line, Upper Level, and Lower Level.
The Upper level is 50, and the Lower Level is -50; this is typically considered over-bought and oversold.
CMO Cross-Up
Let’s take a closer look at the Chande Momentum Oscillator. The CMO Study uses the concept of upper and lower levels to signal extreme momentum to the upside or extreme momentum to the downside.
Evaluating a move’s strength allows us to avoid entering trades with no velocity behind the move. This Momentum study is measuring the strength of the move.
However, there is no signal for taking a trade other than the zero line. If we leave the CMO with only this zero-line crossover as our trade signal, we will miss out on some great trades.
To fix this, most traders add a rolling average to the CMO and use that for trade signals. The typical Simple Moving Average traders use is set to 10, providing crossover signals for our trade entries.
When the CMO crosses above its 10-period average, we can use that as a buy signal, and when the CMO crosses below its 10-period average, we can use that as our sell signal.
Why? A CMO that is above the ten-period SMA is an indication that momentum is above average; this means that not only is there momentum, but there is also ‘above average’ momentum.
Chande Momentum Oscillator Formula
The Chande formula calculates the difference between the sum of all recent gains and the sum of all recent losses. Then, divide that by the sum of all price movements in the look-back period. The results are multiplied by 100 to get the -100 and 100 boundaries. It’d be extremely unusual to see the Chande Momentum Oscillator reach the -100 or 100 levels. The equilibrium point for CMO is the Zero Line. Check out our service for more ways to trade using indicators.
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Crossover
The picture shows a signal generated when the change momentum oscillator crosses above the 10SMA.
A warning signal was also generated when the CMO crossed the 50 line. These signals offered an opportunity to participate in the move and gave assurance of remaining in the trade until a warning signal was given.
The Chande Momentum Oscillator was developed for a high time frame. I’ve found it very useful on daily and weekly charts.
It helps me determine my swing trade entries and exits using a CMO setting of 13 with a rolling average of 10. While a trader could use this on an intraday chart to monitor momentum, I believe there are better indicators to use intraday and that daily, weekly, and monthly charts are the more accurate timeframes for this study.
Divergence With Chande Momentum Oscillator
This is the Divergence Series, AND I’ve focused on divergence in trading because divergence gives traders an early indication of change. I’ve developed divergence signals in various studies to help us spot the divergence more easily.
Typically, divergence is found by drawing trend lines on the CMO from peek to peek or valley to valley, looking for a divergence between price action and CMO signals.
Bullish Divergence
When the price forms a lower high while the Chande Momentum Oscillator forms a higher high, this is a Bullish Divergence. Typically, we would draw trend lines from price peek to price peek.
Look for divergence with the divergence signal added to the CMO indicator from CMO peek to CMO peek. You’ll see the Bullish Divergence, even if it’s only a slight divergence, without having to measure each peek.
The Bullish Divergence signal is a green dot on the Zero Line. When the price forms a higher high while the CMO forms a lower high, this is Bearish Divergence. The Bearish Divergence signal is a red dot on the Zero Line.
Bearish Divergence
After a strong rally, the Chande Momentum Oscillator indicator gave a Bearish Divergence signal, indicating that the continued price action in the upward trend was not to be trusted.
The CMO had already crossed below the SMA, indicating that momentum was below average. The Divergence Signals indicated that the attempts to cross back above the SMA were fakes.
Fibonacci Measurement
While measuring the CMO with my drawing tools, I noticed that Fibonacci lines made this easier. As a result, I’ve added Fibonacci Lines to this study.
I’ve also made it easy to turn these lines off since they offer some clutter in the study. I like turning the Fibonacci lines on to see a measurement after giving a divergence signal. Then, turn the Fibonacci lines back off when I’m done.
Divergence Study User Dialog Box
The above picture shows the user dialog box for the CMO Divergence Study. Don’t let all these boxes intimidate you!
I’ve added a user hint for the CMO and the SMA to offer typical settings. I’ve also added a one-click ability to turn on / turn off the fib lines by choosing yes or no in the “Plot Fib Lines Box.”
This study also has built-in crossover alerts, which can be turned off by choosing ‘no,’ which is better than opening the lower alerts settings and clicking each alert (check out our different types of stocks page).
Labels and Alerts
The above picture shows an Alert Message that’ll trigger when the CMO crosses above/below the SMA. You also see the section called Globals.
This is the section for changing the label colors. Labels? Yes! I’ve added labels that’ll pop up when crossovers happen. Why?
Well, there’s more than one way to use this study. If you already have too many lower indicators and don’t have room to add a new study to the lower area of your charts, you can add this study to the chart section instead.
I’ve added the ability to mark crossovers with a line that runs through the chart when a crossover happens. You can see that in the picture below.
Trend Following
The Chande Momentum Oscillator works well with Keltner Channels to identify strong-trending stocks. I use trend changes on the Chande Momentum Oscillator to generate signals and breakouts above/below the Keltner Channel to confirm.
- Go long when Chande Momentum Oscillator completes a higher trough and price breaks above the Keltner Channel;
- Go short when Chande Momentum Oscillator completes a lower peak and price breaks below the Keltner Channel;
- Exit long positions if the close is below the Keltner Channel and
- Exit short positions if the close is above the Keltner Channel.
- Troughs or peaks are completed when Chande Momentum reverses across the zero line.
Putting It All Together
So, how does it all come together? In the picture below, you can see the Keltner Study presented as a gray cloud. The CMO study offering lines go through the candles when the CMO crosses above/below the SMA in the upper chart area.
Meanwhile, the lower CMO study gives the trader a visual of the CMO if they want it. With the ability to place this study in either section of the chart, I feel that there’s more diversity.
Final Thoughts: Chande Momentum Oscillator
The Chande Momentum Oscillator is a great tool for swing traders to measure the momentum of a move to determine if a trade should be taken or avoided.
With divergence signals added, we can spot potential fake outs, reversals, or lack of true momentum in the price action. Use the SMA to identify when price action has above-average momentum and to give entry or exit signals.
Make sure you get comfortable using this study before placing trades. I also understand that price action, support and resistance, and price structure are always the best tools to assist with developing a trading plan.
Chande Divergence Study: http://tos.mx/z9lyq7
