Posted by Danny on September 14, 2013
A few weeks ago I introduced the “MoM” indicator in the context of my weekly key reversal levels. In this post I will give more info on the MoM and how to use it.
The main idea behind the key reversal levels is “market orientation”, where is the market right now, and where it appears to be going… While charts are very nice and can give us an intuitive “feel” about a given market, they generally contain way too much information. All the years prior tell us where the market has been, but all that “history” is not necessarily very helpful information. We can keep an eye on the past, and it deserves perhaps 20% of our attention, but if we are to trade succesfully then 80% of our focus has to be on the *now*. And that’s the problem with charts, they typically show us only 1% now and 99% past. So, they tend to keep a trader stuck with the past.
The key reversal tables try to summarize where we are right now. Is it a bull or bear market, and is the market rallying or declining? At what key price levels can we consider a change from rally to decline (or from bull to bear)?
That’s all a trader or investor really needs to know.
The MoM indicator is an even more condensed format as it simply tells us where we are on a numeric scale between 10 and -10. You could compare it to the Richter scale for earthquakes, or a market thermometer if you want.
Various levels in the MoM indicator correspond to market mood as follows:
* +8 to +10: very optimistic – euphoric (red)
* +5 to +8: optimistic (pink)
* +3 to +5 : positive (orange)
* -3 to +3: neutral (yellow)
* -3 to -5: negative (green)
* -8 to -5: pessimistic (blue)
* -10 to -8: very pessimistic – depressed (dark blue)
To see how this works in practice, here is a chart showing you the recent history of the MoM indicator on the weekly Dow Jones chart (click for larger image):
Good buying opportunities typically occur when MoM bottoms below -5 in the blue pessimistic zone, as was the case in September 2011. Bull markets will usually see the MoM rise into the optimistic pink or red zone, where they can stay for a while. So, a rise above +5 is not a reason to sell immediately, but one should watch out when the MoM starts going down from optimistic levels. Ordinary counter trend pullbacks or rebounds will typically bottom or peak in the yellow zone (+3 to -3) before resuming move in direction of the longer term trend.
Notice how most of the time the market moves in the same direction as the MoM, and that’s why we watch carefully whether MoM is going up or down.
On weekly charts it is rare to see MoM go below -8, but when it does so it are almost always great long term buying opportunities.
On daily charts we will see the MoM go to extreme values more often. Here is a recent daily chart for Dow Jones (click for larger image):
Over the past year we had three drops into the blue pessimistic zone, which presented good buying opportunities.
You can also see why MoM rising into the red optimistic zone is not a reason for instant panic. In ongoing bull markets we will regularly get a sideways pause or mild pullback with the MoM falling back into the yellow neutral zone before starting the next swing to the upside. We then get a series of MoM peaks in the red optimistic zone. So, we can just move our protective stop closer to the market whenever the MoM turns down in the red zone. That will get us out when a deeper correction comes along, as was the case in May-June and in August.
There are more possible uses for the MoM, but that will be for another post. And in case you wonder: yes, it is possible to trade based on this MoM indicator only. In fact, a patient long term investor can do very well based on the weekly MoM only.