INDICATORS
Buyers And Sellers And Momentum -- Oh, My!
Strength Figure
by Alex Saitta
Here's an indicator that captures the amount and the distance of price thrusts.
Technicians measure the strength of a market trend by examining trading volume, open interest, or price momentum. Most who choose momentum graph the price above and a momentum line below. Figure 1 plots the Standard & Poor's 500 futures, and the difference between the most recent close and the close 15 days prior -- the 15-day momentum line. In this case, the momentum was positive, so the price trend was up, but as the market rose, momentum fell. The divergence between the direction of the price (rising) and the momentum (falling) indicated the uptrend was losing strength and the trend was approaching its end.
FIGURE 1: MOMENTUM. Conventional momentum analysis plots the change in price for some arbitrary length of time coincidentally with price itself.
PROBLEMS ARISE
A fixed-period momentum line frequently yields incorrect measures of a trend's strength. Let's say a market closes at the 100 level five days in a row (Figure 2). On the fifth day, the five-day momentum reading is zero. On the sixth day the market closes at 101, and an uptrend begins. Thereafter, the market continues to rise one point per day. On the 10th day, the five-day momentum reading would peak at +5.
Buyers are strong. If the market continued to rise, the trend would be considered stronger because the buyers managed to maintain one-point gains for a longer period. The momentum reading, however, would remain at +5. When a price trend is longer than the momentum line's period length, the strength of the trend is understated.
In addition, when the number of days in a trend is shorter than the momentum line's period, the strength of the trend can be overstated. For example, if an uptrend began five days ago and you are using a 20-day momentum line, the latest momentum reading will not solely reflect the strength of the new trend. The reading would be a function of the five-day trend, plus the price change of the prior 15 days.
Alex Saitta is a technical analyst and vice president for Smith Barney Salomon Brothers.
Excerpted from an article originally published in the October 2000 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2000, Technical Analysis, Inc.
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