That’s not just a wink to all the loving mothers out there. I am of course talking about the MoM indicator, one of my three “bread and butter” indicators you can usually find in the charts I post every week. Before taking a closer look on how to use the MoM for index trading I want to start with the current Nasdaq chart:
Both the Nasdaq and the S&P 500 have been making a significant breakout to the upside, brushing aside overhead resistance and not showing any intentions of looking back. This is a scenario I have been warning for last week. We still have to keep an eye on the remaining possibility of a failed breakout, as I discussed in my mid-week post. But if the market keeps forging ahead into March then the scenario of a failed breakout would become unlikely.
The MoM indicator is shown at the bottom of the chart and has now climbed above 8 for first time since early August. For individual stocks it is quite common to see the MoM go above 8 during strong rallies, but for broader market indexes a +8 usually happens only a few times per year. The +8 euphoric zone means the market is red hot and the risk for a sudden pullback, if not the start of a bear market, is high. But that doesn’t mean a pullback is imminent. Just as often a +8 gets worked off through time. That’s what we got in Aug-Oct 2016. We see three earlier cases of MoM +8 in the chart (circled in blue) and you wouldn’t have missed much by selling on those occasions.
Conversely, when MoM drops below -6 into the blue zone it usually marks tradeable bottoms and a -8 (= depressed) will typically indicate a major low. I have marked 7 such opportunities in the chart. It is easy to see that you would have done well by doing some buying at those -6 opportunities and just hold until the next +8 peak. Again, for individual stocks it is more common to see -6 or even -8, but for market indexes it is quite rare. We can use this to do swing trading with just one indicator.
There is a couple more things to know if you want to make the most of this:
1) You do not need to sell on the very first day the MoM climbs above 8. As long as it keeps climbing you can wait. Just move your stops closer to the market when MoM is +8 and wait for MoM to turn down to start selling. If MoM falls back below +8 then do some more selling. More often than not you will be able to get back in at lower prices in the ensuing weeks or months and that’s how you can lower your cost basis.
2) In a strong bull market the MoM may not drop back to the -6 zone all that often and may print a series of peaks in the +8 area. Here is a good example from Nasdaq in 2013-15:
MoM in the -6 zone gave us good entry points, but in the second half of 2013 we see a series of +8 peaks with small pullbacks that take the MoM to the zero level but not all the way down to -6. This happens when the market goes into “climbing up the stairs” mode. Then pullbacks are short and shallow with each new thrust creating another step higher. So, be prepared for this possibility. Actually, the current +8 as shown in the first chart could be the start of such a series. Two pullbacks since the November lows have seen the MoM bottom at zero before turning back up. This is climbing up the stairs until we see a deeper drop in MoM.
3) In major bear markets MoM will often fail to reach the +8 zone on rallies and print series of -6 lows during “waterfall declines”. This is just the reverse of #2. Here is a great example showing Nasdaq in 2008-09:
MoM reached +8 near the peak in October 2007. That was followed by a series of MoM lows in the -6 zone and a persistent failure to reach +8 on rallies. During the crash stage in late 2008 MoM stayed in the -6 zone for months. In this kind of situations patience is of the essence. After a lengthy stay in the -6 zone you will almost always see a secondary low that takes MoM back to the -6 zone, but not as low as during the crash stage. You want to buy on those secondary lows, not during the crash itself. Here we got two of them, November 2008 and March 2009. The next +8 didn’t happen until July 2009, almost two years after 2007 peak.
4) To buy major lows you don’t buy on the first day that MoM dips below -6. At least wait as long as MoM keeps going down and if it is a powerful decline then be aware for possible “waterfall” stages. It will often be better to wait until MoM climbs back above -6 and if there has been a lengthy -6 phase then wait for secondary lows as described above. To show an example for a different market here is the Oil crash from 2014:
A +8 peak in July 2013 was followed by several -6 lows. Those lows gave way to little rallies, but none of them strong enough to reach +8 again in the next 12 months. That signaled weakness. The subsequent waterfall declines kept MoM below -6 most of the time and dead cat bounce rallies couldn’t even get above zero. When you see that it is important to resist the temptation to buy at “very cheap” prices. Just wait. In this case buying when MoM climbed back above -6 in late January 2015 would have given a good entry, but still dangerous as evidenced by the drop to lower lows in March. We want to wait for a secondary low after such a waterfall decline. here is how it continued:
There was a nice rally in early 2015, taking Oil back up to $60 and making many investors think that the bottom was in. But it failed to reach the +8 zone, suggesting ongoing weakness. Soon the price of Oil was sliding to new lows again with MoM staying in the -6 blue zone for almost two months. And then a final washout decline into early 2016 lows just above $25. Notice how the final low in February 2016 came with MoM bottoming well above the -6 zone. This is a major bullish divergence, a common feature at the end of long declines. The next +8 peak came in August 2016, almost 3 years after the previous one. This is how patient we have to be in major bear markets.
Reading the market is a difficult challenge and always will be. There are no perfect tools for that purpose. But MoM indicator usually does a decent job. The MoM for major indexes is posted on my Twitter every day.