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Lesson 4 - Momentum
Mark Putrino, CMT
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Momentum
▪ Momentum is a measure of how far a market has moved in a particular period of time
▪ Momentum is not the same as volatility. A stock could be very volatile, but if it ends up in
the same place that it started in the given time period the momentum would be neutral
▪ Stocks usually stay within their typical or normal trading ranges
▪ Overbought means a market is trading at an extreme above what would be its usual or
typical trading range
▪ Oversold means a market is trading at an extreme below what would be its usual or typical
trading range
▪ When a market is overbought or oversold, there is a good chance that it reverses back into
its average range
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Measuring Momentum
▪ There are numerous ways to measure momentum. They can be very simple or extremely
complicated
▪ It is important to understand that these are various ways of measuring the same thing
▪ Most investors simply use the default settings. For deeper insight, oscillators can and
should be optimized for particular securities or markets
▪ Why is this important?
▪ Oversold markets tend to rebound or rally
▪ Overbought markets tend to sell off
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Popular Momentum Indicators
▪ Relative Strength Index (RSI)
▪ Rate of Chance (ROC)
▪ Stochastics (TAS)
▪ Commodity Channel Index
▪ Bollinger Bands
▪ Dozens if not hundreds more
▪ Different ways of measuring the same thing
▪ Can use different time periods and settings for different stocks
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American Airlines
(AAL): Daily
Stochastics, RSI, and
ROC
These three momentum indicators or
oscillators use the default settings.
They look similar because they are
different ways of measuring the same
thing – how far a stock has moved in a
given time period. This chart measures
the movement over days.
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Foot Locker (FL) –
Daily RSI
The daily RSI with the default has
given great buy and sell signals for
Foot Locker.
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Silver – Weekly RSI
Indicator
The indicators can be applied to
different timeframes. This weekly
chart of silver uses the default setting
of 14 time periods or weeks. As you
can see, it has given great signals for
silver.
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Barnes Group (B) –
Commodity Channel
Index
The Commodity Channel Index is a
popular momentum indicator. Here it
gives relatively good signals for the
Barnes Group.
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S&P 500 SPDR Fund
(SPY) – Weekly RSI
The weekly RSI Indicator showed the
overbought conditions in early 2020.
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NIO Inc (NIO) – Daily
RSI
The daily RSI indicator with the
default settings has given great
signals for NIO.
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Exxon Mobil (XOM) -
RSI
The default settings of the RSI have
given good signals for Exxon.
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Okta (OKTA) –
Combined RSI
Combining the 12- and 24-day RSI
has given good sell signals for OKTA.
Combining different time frames can
lead to accurate signals.
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Martin Pring’s KST
System
This system uses ROC. It combines three
different time horizons. The one on the
top uses six days, the middle one uses 12
days, and the bottom uses 24 days.
When oversold or overbought conditions
appear on all three simultaneously it gives
a buy or sell signals.
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Morgan Stanley (MS) –
RSI
Settings can be adjusted for different
stocks. When stocks are rallying, it’s a
good idea to increase the top line
parameters.
In this example the upper red line on the
RSI Indicator is set at 75 instead of the
normal default of 70.
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eBay (EBAY) – RSI
Settings can be adjusted for different
stocks. When stocks are selling off, it’s a
good idea to increase the bottom line
parameters.
In this example lower red line on the RSI
Indicator is set at 35 instead of the normal
default of 30.
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Tesla (TSLA) - RSI
Tesla is a volatile stock so the upper line
on the RSI Indicator is set to 85. It has
given accurate sell signals.
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Edwards Lifesciences
(EW) - RSI
Adjusting the upper line to 80 and the
lower line to 35 has given accurate buy
and sell signals for EW
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Bollinger Bands
▪ Most trading is done by computerized algorithms
▪ Many of these algorithms are driven by probability theory
▪ Probably theory suggests that 95% of all trading should occur within two standard
deviations of the average
▪ The default settings for Bollinger Bands are two standard deviations above and below the
recent 20-period average
▪ If a stock exceeds these thresholds traders will be expecting a reversion to the average
▪ They will enter the market as buyers if a market is oversold and may push it higher
▪ They will enter the market as sellers if a market is overbought and may push it lower
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NIO Inc (NIO) –
Bollinger Bands
The red line on the chart in two standard
deviations above the 20-day average
price. The blue line is two standard
deviations below it. When the stock
exceeded these important thresholds a
reversion to the average followed.
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Shopify (SHOP) –
Bollinger Bands
Bollinger Bands have given accurate buy
and sell signals for Shopify. Each time the
stock traded more than two standard
deviations away from the average a
reversion to the mean followed.
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Facebook Shares Are
About to Get
Hammered -
8/27/2020
The stock is overbought. It is trading at an
extreme distance above its recent
average. This will bring sellers into the
market.
The black line on the following chart is
the day-to-day price of FB. The red line is
two standard deviations above the
average trading price of the prior 20 days.
Now that the black line has crossed over
the red line, the price of FB is more than
two standard deviations above the 20-
day moving average of its price. This
means it is extremely overbought. This
will draw sellers into the market.
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Square (SQ) –
Combining Bollinger
Bands – 20-day and
20-week
The blue lines on the chart are Bollinger
Bands based on the 20-day moving
average. The red lines are Bollinger
Bands based on the 20-week moving
average.
Combining the two time periods has
given accurate signals.
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Lowes Companies
(LOW) – Bollinger
Band sell signal
Each time Lowes exceeded its upper
Bollinger Band a selloff followed.
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Applied Materials
(AMAT) – Bollinger
Bands and RSI
Combining Bollinger Bands with the RSI
has given accurate buy signals for
Applied Materials.
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Li Auto (LI) –
Combined Bollinger
Band and RSI buy
signal
Li Auto fell below its lower Bollinger Band
at the same time that RSI flashed a buy
signal. Combining indicators is a good
way to make low risk trades.
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DeMark – General
Motors (GM)
Tom DeMark created a strategy called a
sequential that finds an overextended
price move, one that is likely to change
direction and takes a countertrend
position.
Setup. There must be a decline of at
least nine or more consecutive closes that
are lower than the corresponding closes
four days earlier. If today’s close is equal
to or greater than the close four days
before, the setup must begin again.
The opposite is true for sell signals.
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DeMark – Palantir
Technologies (PLTR)
The DeMark Sequential setup has given
good signals for Palantir Technologies.
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DeMark – Apple Inc
(AAPL)
The DeMark Sequential setup has given
good signals for Palantir Technologies.
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Optimization(?)
▪ Hedge Funds spend millions on this. They hire (literally) NASA scientists and PHDs to do
so. But they still can’t figure it out!
▪ There is no proof that shows complex momentum indicators give better signals than simple
ones
▪ There is no need for complex regression analysis
▪ Simple ‘eye-balling’ a particular indicator on a stock or market and making adjustments will
prove to be profitable
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Summary:
▪ Momentum is a measurement of how much a stock has moved in a given period of time
▪ Stocks that are oversold tend to rally. Stocks that are overbought tend to sell-off
▪ There are many ways to measure momentum
▪ There is no proof that complex momentum indicators give better signals than simple ones
▪ Momentum oscillators and indicators can be optimized for a particular stock or market. Try
to use settings other than the defaults. Profits will follow
▪ Combining indicators with different timeframes can give low risk signals for profitable
trades
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