Today I'm going to present you with a very busy chart that might be very intimidating, especially for those of you who are new to TA and taking a stab at it while following along with my continuing presentation of the basics, but I encourage you to take heart and be reassured that with not too much time and effort, you will be able to make sense of what at first glance might look a lot like hieroglyphics.
Here's how I'm going to structure this in order to simplify and try to make it as easily understood as possible. First I'm going to bullet list the various momentum indicators with a few of their key signaling characteristics. Secondly I'm going to describe how they have come to bear on the daily time frame on the Dow Jones Industrial Average over the last 2 years. In finishing, I'll also add some additional comments incorporating some of the TA principles presented in previous articles and bring things to the present day.
Momentum indicators and a few of their key signaling techniques:
- Williams %R: Overbought Strength and Oversold Weakness; Overbought/Oversold Reversals; Swing Failures
- Stochastics: Overbought Strength and Oversold Weakness; Overbought/Oversold Reversals; Divergences; Swing Failures
- ROC: Overbought/Oversold Reversals; Centerline Crossovers; Swing Failures
- CCI: Overbought Strength and Oversold Weakness; Overbought/Oversold Reversals; Divergences; Centerline Crossovers; Swing Failures
- RSI: Overbought Strength and Oversold Weakness; Divergences; Overbought/Oversold Reversals; Centerline Crossovers; Swing Failures; Trend Strength
- MACD: Divergences; Overbought/Oversold Reversals; Signal Line crossovers, Centerline Crossovers; Trend Strength
- ADX: +DI -DI Crossovers, ADX DI Crossovers, ADX Trend Strength
- 5,8,13 EMA Trio: Reversals, Crossovers and Alignment
As you can see, there are some critical signaling concepts common to many:
- Overbought Strength and Oversold Weakness: when a momentum oscillator reaches and stays in either extreme, the common interpretation is that the underlying instrument is showing sustained strength or weakness - the exception is when the underlying is in a trading range corresponding to the time frame being used, in which case, the indicator spends little time at extremes
- Overbought/Oversold Reversals: the indicator reverses and moves out of the extreme readings region in opposite direction to that going in
- Divergence: failure to confirm price extremes on the part of the indicator, either bullish or bearish depending upon the context
- Swing Failure: the indicator fails to make a complete move from one extreme to the other
- Signal Line Crossovers: when the fast sub-indicator crosses the slower, smoothed sub-indicator on indicators that use more than one internal indicator
- Center Line Crossovers: when the indicator crosses the centerline (normally 50% or zero) and important commonly accepted boundaries like 66 and 33 on the RSI
- Trend Strength: Higher high, lower low confirmation or lack of (divergence), trendline support/resistance, slope, and length
The chart has been divided into bullish and bearish periods, with the bearish periods being delimited with the vertical diffused red bands, and the bullish periods being the rest. Remember, we are dealing with the daily time frame. What immediately stands out within the bearish red banded periods is the frequent appearance of the Bearish Swing Failure. I've indicated these with short horizontal red lines (and their most recent counterparts with short horizontal green lines). These bearish swing failures show how the indicators, when rallying out of oversold, prematurely reverse lower once again, denoting extreme weakness.
Equally important to momentum studies, the Bearish Divergence that immediately precedes these bearish periods also readily stands out (indicated with down sloping red lines to emphasize the declining peaks in contrast to the still rising peaks in price). These bearish divergences illustrate a tiring bull running out of steam and are the primary warnings of impending weakness and potential for reversals lower.
Prior still to both of the aforementioned characteristic traits, and now backing up into the meat of the bullish periods, we see continued Overbought Strength as the indicators made higher highs relative to each individual rally phase, confirming the higher highs being made in price. Theory says that a higher high on the indicator points with a fairly high degree of certainty to an eventual even higher high in price, and, indeed, that's what has happened on the Dow these last couple of years. I've indicated where there has been a preponderance of bullish peaks on the indicators with green triangles about half way down the chart, and red triangles for the bearish spike lows. Sometimes signals are weak and not confirmed by other indicators of similar nature, and when studying the chart pattern of higher highs and higher lows and their inverse counterparts, we can see that this theory has worked rather well on the bullish side, but not so well on the bearish side. In fact, just last November we saw a great example of this anomaly! I've marked it with a yellow triangle: a lower low on the indicators that was not followed by a lower low in price. (Of course, when talking about anomalies, I'm limiting myself to the approximate 6 month cycle that marks the major lows on this chart. You can also find more minor low examples in shorter cyclic periods, like that on a couple of indicators from this last February.)
Within the longer, overall, 2 year period under study, we see extremely few new lower lows in the long term context, and in the case of the RSI and MACD, we actually have uptrends in place (I've indicated in pink the longer term lower extremes, some horizontal, and others rising). This is a strong indication that the longer term trend remains well entrenched. What we have in between is a pattern of higher lows within each individual period that eventually break with a lower low, but nothing significantly lower relative to the entire period, or outside of the 6 month cycles themselves (I've also put some basic cycle studies around the green and red triangles to further illustrate this). Note also the general pattern of 3 higher highs within each bullish period and the confirming higher lows - until a failed attempt at a 3rd higher high at the end of the last bullish period.
Unlike basic trendlines and S/R levels, which are much more objective in their manifestation and interpretation, momentum, while being completely objective in-so-far as what has already transpired, is much more subjective when it comes to its interpretation. It's been said that TA is part science, and part art, and momentum is an obvious example of science and art blending together. That having been said, I'll now venture a long term Trend Strength synopsis: the Dow exhibits long term momentum strength in a steady and sustained uptrend as seen in a pattern of successive bullish periods characterized by higher high indicator confirmations in combination with a trending MACD and ADX bull spike confirmations, and normal corrective pullbacks that are also confirmed by expected divergent indicator behavior, with the only exception to what we call 'expected behavior' being the tendency for spike lows to form in the absence of a restructuring of the price / indicator relationship (i.e., the absence of a bullish divergence on lower price lows), which, in and of itself, would lend even more argumentative support to 'steady and sustained long term momentum uptrend' thesis. Short to intermediate term, the Dow, as indicated by the same momentum indicators' shorter term absolute readings, has been inside a momentum downtrend that is either a corrective phase or the beginning of a longer term downtrend.
When combined with key trend and S/R elements discussed in my last two articles, Let's Talk Trends and Let's Talk Levels, the preponderance of evidence is still bullish longer term. There's an original trendline off the 2011 low with 5 price validation touches (4 as support and the one in the middle as resistance) that is still exerting its influence and is where the last short term low found support. That particular level is also a combined 50% retrace of a short term, daily extended high to high Fib. draw, and short term consolidation range upper limit S/R from late March, early April. Also note the long term mid-channel that price dipped below, but has now regained, which also basically coincides with the early June spike low. The 100 day SMA is right there as well, and between the 6, they all make up a very nice short term confluence of support. But for how long? And with what kind of strength? Remember what I said at the end of my last article Let's Talk Levels?
"As always, we need to know what the possibilities are, and in this case that means knowing our levels and their relative importance, and then, as we move back to our shorter term trading time frames, watch what price does as it comes into them and be ready to act accordingly."
While this level is very short term and was not included in that particular article's analysis, with momentum now alerting us of a potential shift, we should start giving more attention to it. Based on what we are seeing as price has come down into this short term confluence of support and bounced, we can now begin to give it more importance from a short term standpoint and perhaps even bring it front center to our computer screens. In fact, yesterday we actually got Bullish Oversold Reversals on all these indicators on the daily time frame. We also got a Bullish Signal Line Crossover on the Full STO, and price moved back above the 5 and 8 day EMA's and the early June spike low neckline level as well. The ADX is leveling off and the +DI and -DI have reversed. From a purely momentum vantage point, this is minimal evidence of a momentum shift, but surely enough to consider it a cover shorts signal, or even a signal for an initial small spec long. Further confirmation would come with breaks of indicators' descending lower highs trendlines, Bullish Centerline Crossovers, a bullish signal line crossover on the MACD, a bullish cross of the 8 day EMA by the 5 day, and a bullish +DI -DI cross. Beyond that we'd be looking for a completed move into overbought regions negating the swing failure possibility, a complete positive realignment of the 5,8,13 EMA trio, and a break in the short term descending channel on price itself. In my opinion, the biggest hurdle for bulls to get over right now is the swing failure possibility, especially since recent extreme lows on the momentum indicators place good odds for a lower price low near term. If they can do that and move the momentum indicators back into sustained overbought strength once again, then we might be looking at new highs in price, but that's still a very big IF at this point.
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