Tuesday, February 12, 2013

Chapter 2: Momentum

Chapter 2     Momentum

     Momentum is like the Physics definition.  An object in acceleration stays in motion unless met by an equal and opposite force.  Trading with Momentum we use oscillators, moving averages and volume to measure a securities rate of change.  

     Momentum Indicators are fixed on a scale of for example -100 and 100 others can be different many can be manipulated.  Lets use an example of the Inverse Fisher Transform RSI.  On the chart provided the #3 on the lower indicator is the Inverse Fisher Transform RSI.  On the chart the Inverse Fisher indicator is oversold and is turning down on a weekly time frame.  For me this is a big indication that prices will follow because momentum has changed.
     Momentum is elastic and from the zero point on the scale Oscillators experience extremes.  These extremes are like a stretched rubber band.  When you pull a rubber band apart you can feel the force getting stronger to pull in the opposite direction back to zero. The best way I can interpret Momentum is to do this exercise while looking both at the rubber band and the Oscillator together.  Now Momentum is said to be oversold and overbought when it is at the extremes of 100 and -100.  When at the Oscillators extremes, Momentum then can lose acceleration and change direction.   What I have realized over the years is that the elasticity of  the rubber band pulls back to zero and just like a rubber band price action most likely will pull back to meet up with most likely its trendlines, moving averages, or support lines.  There are always exceptions and you should know that an explosion in price up or down, the oscillators can and will stay at its extremes for long periods of time.  On a chart when momentum changes you can see price react.  Oscillators are known to be leading indicators ie; oscillators lose momentum and change direction and prices follow.

     Although in many cases you can see prices move drastically without an Oscillators notice.  Volume is also a leading indicator.  When you have a sudden explosion in volume you can see prices follow.  My favorite is to follow stocks that are about to break price patterns on weekly charts and to pay attention to volume.  Volume that is higher for the day and more than the monthly averages has been a good place to consider. When price and volume act together and move past resistance or support you can assume it is a higher probability that momentum will carry prices in that direction until an equal and opposite force act upon it.

Double Top or Head & Shoulders?

Changes in Momentum

     On the chart provided, lets  go over the notations.  We have all ready mentioned the Inverse Fisher Transform indicator. Candlesticks on the other hand tell the story, and I recommend you should add them to your charts.  The weekly Tweezers Top.  Tweezers are very easy to find and use.  Absolutely nothing is guaranteed but Tweezers are qualified by the same close at the end of the wicks.  Tri-tips are even better.  Do some research, find numerous weekly charts of your favorite issues.  Circle how many times you see double and triple long wicks signaling a turn in the market.  They are easy to see and easier to trade.  Always wait for confirmation or a close outside the previous candlestick. 

      Another Candlestick pattern and reversal opportunity is the Doji.  A Doji is looked at as an indecision day on the charts.  Buyers and Sellers look to be at a stalemate. The close on the Doji should be very close to the opening and the wicks can be as long or short as possible.  A very good example of tops and bottoms in the market.  In addition the Doji can be considered a point on the chart of support and resistance.  Again wait for confirmation, a close outside the lows or highs of the candle and follow the Momentum.    

     Finally several other Candlestick patterns are available to study and tell a story on how the market is behaving. 
1. The Hammer is a bottom reversal pattern. You can look up the definition ad is described as "hammering out a bottom"
2. The opposite of the Hammer is the Hanging man formed at tops of the market and is another reversal candlestick pattern.

    Trading the reversals is opening a position outside the candlesticks formation.  On a bottoming formation of the hammer you go long when the price closes over the top of the candle.  On the top formation of the hanging man you do the same but in opposite direction.

    There are many more reversal pattern in candlesticks and are very valuable to use and to learn for your Technical Analysis arsenal.  

Doji on daily chart acting as Support