When it comes to market timing, you are either a believer or not. Whilst arguments for and against market timing have been plentiful over the years, this article will not aim to add to those arguments. Instead, this article will give 5 indicators that will be helpful for those that believe in market timing. I have tried to succinctly summarize each of the indicators below in order to give you a fast read and a basic understanding on how each of the concepts work.
There are over 80 market indicators divided into 6 categories (trend, momentum, volatility, market strength, support/resistance and cycle). That being said some are very technical, some are infrequently used and some are more effective than others. This article will deal with t5 of the most popular Momentum Indicators which are listed below:
1) Stochastic Oscillator (SO) – compares a security’s closing price to its price range over a given period of time.
The theory behind this indicator is that in an upward-trending market, prices tend to close near their high, and during a downward-trending market, prices tend to close near their low.
There are two components to the Stochastic Oscillator:
- the %K which is the main line indicating the number of time periods (usually 14).
- the %D which is a three-period moving average of the %K.
Buy/sell signals occur when the %K crosses above/below the %D.
For example, A %K result of 70 (or 30), is interpreted to mean that the price of the security closed above 70% (or below 30%) of all prior closing prices that have occurred over the past 14 days and assumes that the security’s price will trade at the top (or at the bottom) of the range in a major uptrend (or downtrend). A move above 80 suggests that the security is overbought and therefore should be sold while a move below 20 suggests that the stock or index is oversold and, as such, is a buying signal.
2) Relative Strength Index (RSI) – compares the magnitude of recent gains in price to recent losses in an attempt to determine overbought and oversold conditions of a security.
The RSI, on a scale of 0-100, indicates that a stock is:
- overbought when it is over 70
- oversold when it is below 30.
Because large surges and drops in the price of a security will create false buy or sell signals the RSI works best when it is used in conjunction with short-term moving average crossovers such as the Stochastic Oscillator to confirm a directional shift.
3) Price Rate of Change (ROC)– measures the percentage rate of change, indicating the strength of the momentum, between the most recent price and the price over “x” periods (the narrower the better) thereby identifying bullish or bearish divergences.
As such, the ROC is able to forecasts sooner than almost any other indicator an upcoming reversal of a trend and whether or not a security’s price action is created by those over-buying or over-selling it.
A number other than zero (a personal choice) can be used to indicate an increase in upward momentum and a number less than zero to indicate an increase in selling pressure.
4) Commodity Channel Index (CCI) – an oscillator which quantifies the relationship between the security’s price, a moving average of the security’s price, and normal deviations from that average to determine when a security has been overbought or oversold.
The CCI, when used in conjunction with other oscillators, can be a valuable tool to identify potential peaks and valleys in the security’s price, and thus provide investors with reasonable evidence to estimate changes in the direction of price movement of the security.
5) TRIX – displays the percent rate-of-change of a triple exponentially smoothed moving average of a security’s closing price and is designed to filter out stock movements that are insignificant to the larger trend of the security.
The user selects a number of periods (such as 15) with which to create the moving average, and those cycles that are shorter than that are filtered out. TRIX is also a leading indicator and can be used to anticipate turning points in a trend through its divergence with the security’s price.