Some of the e-mails I get are from people asking how to predict a forthcoming price change before it takes place.
Most of the technical indicators I have discussed earlier usually identify a change after it has taken place, today I will focus on an indicator group that can predict a change before it takes place. Momentum indicators or oscillators as many of you may be familiar with the term are technical indicators that usually warn of concealed strength or weakness well ahead of the final price move. A moving objects momentum is defined by the objects mass times its velocity. Markets have momentum, similar to moving objects’ momentum. The analogy of the pendulum can further explain the concept; a pendulum for instance has constant momentum, the pendulum moves back and forth around a baseline if plotted against time.
In markets velocity would be the fluctuating prices whereas mass would be changing volume. The right and left move of the pendulum would correspond to tops and bottoms for each market or stock price.
Momentum is either upward momentum or downward momentum. Upward momentum can be explained by throwing a ball up, as the ball reaches its turning point, it starts to slow down, it loses momentum, the same thing happens at the end of a bull move the speed by which prices increase begins to slow down before it suddenly changes direction.
Downward momentum can be clarified by picturing a car falling over a hill, as the car starts its journey down the hill its speed starts to pick up until it suddenly stops, although before it stops it continues to move but with a slower speed, losing its momentum. A bearish move in markets, acts in a similar manner. The simplest type of momentum is the rate of change momentum indicator. Rate of change (ROC) indicator is the rate of which a securities price is calculated over a given period of time, the time span depends on the period under observation, short, medium or long.
As an example to calculate the ROC for a 25-day time span, the current price is divided by the price 25 days ago, the subsequent reading will be calculated by dividing the next days price by the price 24 days ago, and so on. The result would be a price series that oscillates around a central point, drawn under the price of the stock specified.
Do not worry about the calculations since “Mubasher” the real time stock market dissemination service does the calculations and plotting for you all you need to do is specify the time span wanted. The simplest methods of interpretation are that changes in the (ROC) usually precede changes in the actual price its self. When the line moves to the top of the range the security is said to be overbought, this is usually a warning that a change of direction will take place, especially if the line flattens out. An oversold condition occurs if the line moves to the bottom of the oscillating range, this is an excellent buying opportunity, it indicated that a security is oversold and selling pressure is easing.
Another possible interpretation for the (ROC) momentum indicator would be if a divergence occurs between the (ROC) momentum indicator and the price of the security, the bigger the divergence the more significant the warning that the security will change direction and follow the direction of the momentum indicator.
Momentum indicators warn of technical weakness or strength; a similar situation is the sound of thunder, you hear the sound and see the lightning — you know that the rain will follow shortly afterward even though you do not see it or feel it.