Have you heard of the Chande Momentum Oscillator CMO indicator and would like to learn how to use it? In this article, we will explain how to use CMO to improve your trading strategies.
This is not the usual superficial article that you can find everywhere. We will go deeper, analyze data, backtests results, strategies and much more.
CMO Reversal Strategy: The simplest use of the CMO on the stock market
Before reading, please read the disclaimer. This article is for educational purposes only and should not be construed as investment advice.
We divide trading strategies into two macro-categories: trend follower and mean-reverting.
As we have previously explained on various occasions, in mature markets with a lot of liquidity, it is better to use mean reverting strategies.
CMO is an excellent oscillator used to look for trend reversals and is the primary purpose of a mean-reverting strategy.
The US Stock Market, with its main indices, is the best tool to adopt this strategy. Many of the capitalized stocks in the S & P500 index also work well with a mean-reverting approach.
The Chande Momentum Oscillator works similarly to the Relative Strength Index but is much more responsive.
The standard settings of this indicator are 14 or 20 periods, the CMO is generally used through its moving average and the levels of overbought and oversold are respectively +50 and -50. We will use the 14 periods as the setting.
Let’s see what the Chande Momentum Oscillator looks like on a future graph on the S & P500.
When the CMO has a value above 50, it means that the market is in an overbought area. This means that the upward trend may end and a reversal may occur.
Insider tips: the CMO does not signal you a trend reversal; it only warns you that the uptrend moment may run out because the price has gone up too much.
This means that the price could also lateralize for a longer or shorter period and then start rising again.
When this happens, many believe it is a false CMO signal. In reality, when the market sidesteps after hitting an overbought phase, Chande Momentum Oscillator did its job anyway.
When the CMO assumes a value of less than -50, however, we are in an oversold area; the market has fallen a lot and the indicator shows an interruption of the bearish trend.
Also, in this case, the Chande Momentum Oscillator is not signaling a trend reversal, but only that the downtrend could be exhausted and therefore, the market could stop.
As we have explained above, the market could sideways for an indefinite period and then fell again.
Mean Reverting strategy on Google timeframe H1 stock
Let’s build and test a straightforward only long strategy using CMO.
We will use Google on an H1 chart, the Chande Momentum Oscillator settings will be 14 periods and levels 50 and -50.
This strategy is straightforward, there are no money management rules, stop loss, take profit, or filters, but it is based solely on CMO.
Here is the strategy:
- Capital 50k
- Fixed Trade Size 10k
- Buy when CMO < -50
- Close Buy when CMO > 50
The strategy is always on the market. We have carried the test out on the data relating to the last ten years.
As you can see, the strategy performs well, even in its raw state. We have invested only a part of the capital; the single purchase equals 10k on the capital of 50k.
Let’s see the main data of the strategy performance:
|Long profit factor||2.12|
|Average trade long||88.63|
The CMO and the bullish stock market bias
You know that stock markets rise in the long run. Applying short strategies on stock markets is never a good idea unless it is a hit and run and highly speculative transaction.
Chande Momentum Oscillator should, therefore, perform better if used only for bullish signals.
There is also another essential feature of the stock markets that should be taken into consideration: the markets are rising slowly and dropping.
The stock market can lose in a few days what it has gained in weeks or months; we are talking about the indices. The single title, following news or other events, can rise dizzyingly and descend in the same way.
Because of this last feature, the market is much more likely to reverse the trend after a sharp descent with the CMO in oversold compared to a reversal during a climb.
Using only long systems should, therefore, increase the performance of a Chande Momentum Oscillator-based system.
Does Chande Momentum Oscillator work in intraday?
Let’s take the google title as an example once again and apply the same strategy based on the CMO on various intraday time frames at 15 minutes.
CMO Strategy – Google 15 minutes timeframe – last ten years
This equity line is not satisfactory and we can never use this strategy.
Faced with a sharp increase in trades, the profit factor is unacceptable and even the trade in trade barely covers commission costs.
|Long profit factor||1.11|
|Average trade long||7.77|
Let’s try increasing the timeframe to 1 day to see if the Chande Momentum Oscillator’s performance increases:
|Long profit factor||5.17|
|Average trade long||540.91|
We have therefore confirmed what we describe in the first chapter of this article; namely, the strategy with the CMO increases its performance by increasing the timeframe.
The problem is the small number of transactions, considering that the trading system needs at least a trend filter that would reduce the number of trades more.
More about the Chande Momentum Oscillator: TraderPedia.