Speed rather than direction
Trend tools describe which way price has been going. Momentum indicators try to describe how fast, and whether that speed is picking up or fading. The comparison sometimes used is a thrown ball: direction is where it is heading, momentum is how hard it was thrown and whether it is slowing.
Most momentum indicators are oscillators, meaning they move up and down around a centre line or inside a fixed range and are drawn in a panel beneath the price chart. They are calculated purely from past prices, so they describe recent behaviour and do not see the future.
Relative strength index
The relative strength index (RSI) compares the average size of recent up-moves with the average size of recent down-moves over a set number of periods, commonly 14, and converts the result to a scale between 0 and 100. Higher readings mean recent gains have outweighed losses. Common convention labels readings above 70 as “overbought” and below 30 as “oversold”.
Those labels are easy to misread. They describe an unusually strong recent move, not a price that is about to reverse. In a sustained rise, RSI can sit above 70 for a long time. The formula itself is a ratio of average gains to average losses.
MACD
MACD stands for moving average convergence divergence. It has three parts.
- The MACD line: a short exponential average minus a longer one, by default 12 and 26 periods.
- The signal line: an exponential average of the MACD line itself, by default 9 periods.
- The histogram: the MACD line minus the signal line, drawn as bars.
A tiny illustration with made-up values: if the 12-period EMA is 105 and the 26-period EMA is 100, the MACD line is 5. If its signal line is 3, the histogram is 5 - 3 = 2. When the short average pulls away from the long one, MACD rises; when they converge, it shrinks.
Analysts look at the MACD line crossing above or below the signal line, and at whether it is above or below zero. Because MACD is built from moving averages, it inherits their lag, and in sideways markets its crossovers often arrive in clusters of false signals.
Stochastic oscillator
The stochastic oscillator asks where the latest close sits in the range of recent highs and lows. The formula is:
(latest close - lowest low) / (highest high - lowest low) x 100
For illustration, if over the lookback window the lowest low was 10, the highest high was 20 and the latest close was 15, the reading is (15 - 10) / (20 - 10) x 100 = 50. A close at the top of the range gives 100 and at the bottom gives 0. Like RSI, readings near the extremes are labelled overbought or oversold, with the same caveats.
Rate of change
A simpler measure is rate of change: the percentage difference between today’s price and the price N periods ago. If a price was 80 ten periods ago and is 90 now, the change is 10 / 80 = 12.5 percent. It is easy to compute and understand, which is useful for seeing that all momentum indicators are variations on the same basic comparison.
What divergence means
A common talking point is divergence: price making a new high while the oscillator fails to, or the reverse. Supporters read it as a sign the move is losing strength. It is subjective, because it depends on which peaks you choose to compare, and divergences can persist while price keeps moving the same way. As a descriptive observation it is fine. As a forecast it is unreliable.
What oscillators do and do not show
They can show:
- whether recent moves have been stronger on the up or the down side
- whether the speed of a move is rising or falling
- how a current reading compares to the indicator’s own recent history
They do not show:
- when a trend will end
- how far a move will go
- why price moved, or whether news or a large order caused it
- anything about the future
Oscillators also tend to work differently in different conditions. In a ranging market, bounded oscillators swing back and forth in a way some traders find useful. In a strong trend, they pin to one extreme and their overbought or oversold labels mislead. Telling which kind of market you are in is hard until afterwards.
Another limitation is that momentum measures are all derived from price. Using RSI, MACD and a stochastic together can look like three confirmations, but they share the same inputs, so they often move in step. For a broader picture, people also look at trading volume, market sentiment and derivatives data such as open interest, each of which brings its own uncertainty.
Practical cautions
- Keep the timeframe in mind. A 14-period RSI on a one-minute chart reflects only minutes of data.
- Default settings are conventions, not tested optima.
- Price volatility in crypto can produce extreme readings quickly and often.
- Do not treat a reading as an instruction to act.
Cryptocurrency prices are highly volatile, past performance does not predict future results, and people can lose everything they invest. This article is educational and is not financial advice.