January 12, 2013

Momentum and Short Term Analysis Indicators for Day Trading

The internal dynamics of the market are really the only thing you have to analyze the short term. These include three groups of momentum indicators: price, volume, and breadth.

The most important is price, which is a quantitative measure of trend.

Volume and breadth are qualitative; that is, they provide an indication of the quality of the price trend.

stock indicatorsFor example, if the DJIA is rising and the daily advance/decline line (breadth) is rising, then we can say that the majority of stocks are performing in line with the DJIA. This would give the technician a lot of confidence in the upward price trend.

However, if the DJIA is rising and the daily A/D line is falling, it means only a minority of stocks is moving up. In this situation, a technical analyst would not have much confidence in the trend.

Price is better measured using the NYSE Composite Index, because that index is capitalization weighted and very broad-based.

To gauge performance of various sectors of the market, other indexes can be used: The Nasdaq Composite is a good measure of “glamour” stocks, while the Russell 2000 is used to measure secondary stocks. To measure price momentum, technicians use moving averages.

The spread between a price index and its moving average, or between two moving averages of different time periods, measures the intensity of a trend.

For example, a widening spread between two rising moving averages means an overbought market with powerful upside momentum. Conversely, if the index is well below its moving average, it means an oversold market with downside momentum.

The spread between two or more moving averages is used similarly. Volume tends to mirror price. As a general rule, once volume starts to rise, it has to continue to stay high or get higher to maintain the trend. That’s why a big change in volume often indicates that we are late in a trend and that the trend may change.

For example, if the market is rising and suddenly there is a big change in volume, it could signal that the uptrend is coming to a close, especially if price also stalls. On the other hand, declines often end with a stabilization in price and very little change in volume.

Another volume indicator is upside and downside volume. A technical analyst may look at 10- day totals of upside volume, downside volume, and net volume to determine whether a rally is function of increased buying power or decreased selling pressure.

For example, investors may conclude that the market is oversold when net volume becomes deeply negative. Rather, it could be underbought — not as important a condition.

In an uptrend, a market tends to get underbought often and oversold rarely; that is actually a sign of strength.

Breadth is another name for the difference between advancing stocks and declining stocks (also known as the A/D line).

In contrast, the traditional A/D line that most people follow is composed of all stocks on the New York Stock Exchange, which includes closed-end bond funds and preferred stocks. When market breadth is reported as negative, it means there were more stocks declining than rising over that period.

The reverse is true if breadth is reported as positive. If most stock groups are moving in the same direction, the market is said to have strong breadth.

Divergence occurs when a group of stocks rises (or falls) when the market is falling (or rising). That group of stocks is said to be diverging from the market. Group divergences may indicate a market top.

An example would be when the DJIA is rising but more broadly based indexes are not. The number of new highs and the number of new lows is another short-term indicator. Basically, the more stocks making new highs in an uptrend, the more confidence you would have in the trend. New highs tend to peak well before the peak in the market average.

Carl Croft

Carl is an active trader of forex, stocks and commodities who mainly uses charting and candlestick strategies. An author on various trading websites and is admin here!.