The Chande Momentum Oscillator (CMO) was developed by Tushar Chande, who presented it in a co-written work with Stanley Kroll called “The New Technical Trader”. This indicator was designed to calculate what Chande refers to “pure momentum”. The objective of this indicator is to detect trend variations of greater or lesser extent. The CMO is similar, although it is unique in itself, to other indicators oriented to momentum such as the Relative Strength Index (RSI), Stochastics and Rate-of-Change.
The CMO uses data from both bullish days and bearish days in the numerator, directly measuring the momentum. The calculations are developed with non-smoothed data. This allows extreme short-term movements to be less hidden. However, smoothing can be implemented to the Chande Oscillator if desired. The scale of the indicator is between +100 and -100 allowing the user to clearly see changes in market momentum using level 0 as a balance point.
Calculation of Chande oscillator
Structurally, the CMO is similar to the RSI, its only difference being the inclusion of the term Sd (x) in the numerator of the formula.
For a period of “x” bars:
RSI = 100 * (Su / (Su + Sd))
CMO = 100 * ((Su – Sd) / (Your + Sd))
Su = Sum of the price differences on bullish days.
Sd = Sum of the price differences in bearish days.
But this simple modification is, in Chande’s opinion, of the utmost importance, since in this way the CMO is able to capture what he calls “pure moment” resulting, in general, more sensitive to changes.
Interpretation of the Chande oscillator
This indicator can be used to measure different conditions:
- Identify overbought/oversold conditions: looking for extreme overbought or oversold market conditions is the primary CMO interpretation method. As a general rule, Chande oscillator identifies an overbought level at +50 and the oversold level at -50. At +50, the momentum of a bullish day is three times the momentum of a low day, while at the -50 level the momentum of a bearish day is three times the momentum of a bullish period. These levels essentially correspond to the common 70/30 levels for the RSI indicator.
- Chande oscillator with a signal line: entry and exit rules can be created with the CMO by adding a moving average in the Chande oscillator. For example, we can use a CMO with a configuration of 20 periods and a moving average of 9 periods (SMA 9) that can serve as a good signal line. In this case, we must buy when the CMO crosses over the signal line of the SMA 9 and sell when the indicator crosses below this moving average.
- Trend Analysis: The CMO can also be used to measure the degree of a current trend exhibited by an instrument. High or extreme CMO values correspond to a strong trend while low values indicate a possible trading range.
- Divergence between the indicator and the price: although it is not specifically mentioned in Chande’s book, seeking divergences between the CMO and the price of the instrument can also be a viable strategy as it is usually with other similar indicators oriented to price momentum.
Finally, another interesting application of the CMO is its use in the construction of adaptive moving averages with great sensitivity to changes in volatility. Such is the case of the VIDYA (Variable Index Dynamic Average), but this will be the subject for further articles.