Momentum is simply the rate of change – the speed or slope at which a stock or commodity ascends or declines. Measuring speed is a useful gage of impending change. For example,
assume that you were riding in a friends’ car, not looking at what was happening ahead but instead just at the speedometer. You can see when the car starts to slow down and if it continues to do so you can reasonably assume it’s going to stop very shortly. You may not know the reason for it coming to a stop…it could be the end of the journey, approaching and intersection or because the road is a little rougher ahead. In this manner watching the speed provides a guide for what may happen in the future.

An oscillator is an indicator that moves back and forth across a reference line or between prescribed upper and lower limits. When an oscillator reaches a new high, it shows that an uptrend is gaining speed and is likely to continue. When an oscillator traces a lower peak, it means that the trend has stopped accelerating and a reversal can be expected from there, much like a car slowing down to make a U-Turn.

In the same way watching a stock for impending momentum change can provide a glimpse of what may happen in the future – momentum oscillators, such as RSI are referred to as trend leading indicators.

The chart below illustrates the typical construction of the RSI which oscillates between 0% and 100%. You will notice there is a pair of horizontal reference lines: 70% ‘overbought’ and 30% ‘oversold’ lines. The overbought region refers to the case where the RSI oscillator has moved into a region of significant buying pressure relative to the recent past and is often an indication that an upward trend is about to end. Similarly the oversold region refers to the lower part of the momentum oscillator where there is a significant amount of selling pressure relative to the recent past and is indicative of an end to a down swing.