DEFINITION of Chande Momentum Oscillator
The Chande momentum oscillator is a technical momentum indicator invented by Tushar Chande. Chande introduced the indicator in his 1994 book “The New Technical Trader. “It is created by calculating the difference between the sum of all recent gains and the sum of all recent losses and then dividing the result by the sum of all price movement over the period.
The Chande momentum oscillator formula is:
CMO = 100 x ((Su – Sd) / (Su + Sd))
BREAKING DOWN Chande Momentum Oscillator
This oscillator is similar to other momentum indicators such as the Relative Strength Index and the Stochastic Oscillator except that is measures momentum on both up and down days. The oscillator also does not use smoothing which makes it reach oversold and overbought levels more frequently. The indicator oscillates between +100 and -100.
Chande Momentum Oscillator Interpretation
A security is deemed to be overbought when the Chande momentum oscillator is above +50 and oversold when it is below -50. Many technical traders add a 10-period moving average to this oscillator to act as a signal line. The oscillator generates a bullish signal when it crosses above the moving average, and a bearish signal when it moves below the moving average.
The oscillator can be used as a confirmation signal when it crosses above or below 0. For example, if a trader notices that the 50-day moving average has crossed above the 200-day moving average (golden cross), he or she could confirm the buy if the Chande momentum oscillator has crossed above 0; this would suggest prices were showing upward momentum.
Trend strength can also be measured using the Chande momentum oscillator. The higher the oscillator's value, the stronger the trend; the lower the value, the weaker the trend. (To learn more, see: How do I Build a Trading Strategy with the Chande Momentum Oscillator?)
Chande Momentum Oscillator and Price Divergence
Traders can use the Chande momentum oscillator to spot positive and negative price divergence between the indicator and the underlying security. A negative divergence occurs if the underlying security is trending upward and the Chande momentum oscillator is moving downwards. A positive divergence occurs if price is declining, but the oscillator is rising. In the example below, Apple Inc. made a new high in late August and another new high in late September. The oscillator, however, made a lower high in late September, confirming negative divergence. Traders who decided to take a short position in the stock could place a stop-loss order above the September swing high and cover when the oscillator crosses below -50. (For further reading: What Does it Mean to Use Technical Divergence?)