even though it is something that cannot be measured or quantified. Just because you can't really measure it, under those circumstances, it doesn't make it any less real.
Momentum, in that setting, is just a feeling, a sensation or an awareness but it is still there and seemingly a fact. This week just ask any Miami Dolphin football player or fan. They know
what momentum is and also know they never had it last Saturday.
You are probably now asking if it CAN be quantified or measured. Surely it can, at least in most endeavors in life. In the stock market there are numerous methods and indicators used to measure momentum.
In the rocket car example from last week, I used probably the most common stock market method of measurement which is the rate-of-change indicator. The use of the rate of change oscillator will give you a workable measure of whether the momentum is increasing or decreasing for any time period you wish to analyze.
When using momentum oscillators and attempting to interpret them in stock analysis, you will constantly hear that this stock is over sold and that market is over bought. Most momentum oscillators are set up on a chart with a line drawn at an over bought number and another line at an over sold number. These are usually set at 80 and 20 but sometimes at 70 and 30. These numbers or lines, like everything else in technical analysis, are not absolute guaranteed points but are meant to be guidelines.
Over the years there has been much discussion and argument about the numbers that are used for these over bought and over sold levels. There has been enough written on just this one subject to fill up books. Some analysts have insisted on one and can back up their analysis with some cold and hard facts and figures. When you read the other group, they too have some facts which could very well be argued to convince a reasonable person that their figures and facts are the correct
ones.
What I am trying to convey to you here is that you really should take neither at face value. Don't arbitrarily use one over the other or any other number(s) for that matter. Look at your analysis yourself and use what YOU feel are the proper numbers. Test what you do and how it affects your work. What works for IBM probably won't work as well on Intel.
A concept I have stressed in the past that I want to emphasize again concerning an over bought or over sold indication is that just because your stock is over bought, it does not mean it will go down in price. If your stock is over sold it does not mean that the price will rise either. Markets and stocks can get to these two extremes and stay there for long periods of time. They may retrace a little while staying over bought or over sold and then just head higher or lower again.
Even in rare circumstances, I have seen the readings hit 100 or 0 and stay there for a few days using daily readings. Over bought and over sold are relative measurements and not guarantees. You will do well to remember that little tidbit of information.
It goes back to technical analysis being an art and not a science. If I could set up a black box with all the indicators and methods preset to work in all conditions with all stocks and markets this would indeed be a science and we would all be rich; most especially me. Unfortunately, I don't think it can
be done. Technical analysis, in my opinion, has to have the individual eye and mind involved to figure out what to do and when to do it. What's right for me may not always be right for you and vice versa. Don't rely on others to do your analysis for you. Spend the time necessary to learn it and practice it correctly. Even then, you must understand you will not be right all of the time. Thank goodness, to be profitable, you don't have to be.
Now on to some other helpful indicators or methods. The first I want to discuss is divergences. Divergences happen all the time in analysis; they are very common. The shorter the time frame you use to analyze, the more you will probably see. I do most of my work using daily numbers and I see them fairly often.
A divergence in a stock market momentum indicator is when the stock price makes a high along with a high in the indicator you are watching, say a rate-of-change (ROC) indicator. The stock and the indicator then turn down for a few days and retrace before stopping and heading again to higher numbers. The stock makes a higher high while the ROC does not, falling short of the previously mentioned indicator high. This is what is referred to as a divergence. It works the same way in a
declining stock price and indicator.
Sometimes these divergences will set up as a series of divergences. You would have a series of higher highs being made in your stock while the momentum indicator you are watching makes lower and lower highs. This generally predicts a large price trend reversal is on the horizon and you should
pay attention and not get caught off guard when it occurs.
Divergences are wonderful indicators to use to help you foretell if and when a change in direction is imminent. Used with other indicators and also verifying the trend change with the current price action and you will be much better able to trade successfully. You will be able spot and recognize trend
changes sooner, saving you money when you need to make a quick exit and making your more because I know you will then trade the change.
As you get more experience with divergences, how they set up and how they act and react, you will start to recognize the tops and bottoms much sooner than you thought was possible. Suddenly the trees won't be in the way of your view of the forest anymore.