W E HAVE ACCEPTED THAT WE,
AS INDIVIDUAL TRADERS, cannot compete in terms of complexity;
therefore, we need to keep everything as simple as
possible. A simple way to measure trend and
momentum is to use three time periods: short term,
intermediate term, and long term (short
term meaning days, intermediate term meaning weeks,
long term meaning months.)
THE LONG-TERM
TREND INDICATOR
A long-term trend indicator needs to be able to measure,
with reasonable reliability, the price
energy flow of the past few months. For a long-term
trend indicator, SMR and I use a simple tenweek
or 50-day moving average (i.e., about two and a half
months). Actually, SMR uses a 49-day
moving average. SMR attaches some mystical
significance to the number 49. It may or may not
be there; I do not know and do not believe it makes
any difference—49 day, 50 day, same for me.
Regardless, the 50-day moving average is probably the
most commonly used time period to
measure trend; and, most importantly, I have found it
to be more than adequate at doing so.
Actually, I believe it is better to refer to the
long-term trend as the ten-week moving average
rather than a 49- or 50-day moving average. Since I consider long term to mean
months, it is only
logical to measure long term in terms of weeks rather
than days. Additionally, reading
trend/momentum indicators is somewhat of an art, and
any art requires a degree of freedom.
Thinking and referring to trend in terms of weeks
rather than days tends to produce a more
general, and thus freer, way to look at trend.
There are two basic ways to measure trend and
momentum. One is through the use of simple
arithmetic moving averages, like the 50-day moving
average. While I believe a straight mathematical
moving average is the best way to measure long-term
trend, I prefer a different approach when
measuring shorter term price energy flows.
The basic idea in using simple moving averages to
measure trend is that if the price is higher now
than it was a few months ago, then the trend is up
(and vice versa). However, for shorter time
periods (i.e., weeks and days), I believe a more
accurate way to measure price energy flow is
through momentum oscillators.
MOMENTUM OSCILLATORS
An oscillator is a measurement of price energy flow that moves
above and below a neutral point
or line. In other words, this momentum
indicator oscillates above and below a zero line. To construct
a price oscillator, all you do is calculate both a
short-term moving average of the price (say the
closing prices of the past few days) and a slightly
longer term moving average of the price (say
the closing prices of the past couple weeks), and
then simply subtract the second number from
the first. Doing this will result in either a plus or
minus number. Next, plot the daily number this
produces onto a graph and then connect the daily
"dots" to make a line. Net result will be a
momentum line that oscillates above and below zero.
The basic idea of an oscillator like this one is, if
the price has been moving up faster over the past
few days than it has over the past couple weeks, then
the line produced by this type of oscillator
will point up. An upward pointing line indicates the
momentum of the price is upward. (And,
of course, the reverse is true for the downside). An
oscillator provides a good picture of the
direction, and to a lesser extent speed, of
short-term price momentum. Over the years I have
found oscillators, specifically SMR's, tend to be
reasonably reliable indicators of short-term (i.e.,
days] and intermediate-term (i.e., weeks) price
momentum. I believe oscillators are better indicators
of short-term and intermediate-term momentum than
simple moving averages.
Charting software can construct a wide variety of price
momentum oscillators. There are probably
many different specific oscillator formulas that
could work well in trading. The specific
formula a trader uses to construct short-term and
intermediate-term oscillators is not as
important as developing a familiarity with the
oscillator's tendencies and characteristics—just
so long as the indicators are "reasonably
reliable" (as SMR's are).
I have been working with SMR's momentum oscillators
for over a quarter of a century and have
found they easily qualify as "reasonably
reliable" indicators of short-term and intermediate-term
price momentum. In addition, I am very familiar and
comfortable with their tendencies. If you
feel the same about similar oscillators you may have
been working with for a long time, then stick
with them. Remember, moving averages and oscillators
are simply reasonably reliable indicators
of price trend and momentum; none are absolute or
perfect.
THE SHORT-TERM
MOMENTUM INDICATOR
A short-term momentum indicator needs to be a reasonably accurate
measurement of the price
energy flow of the past few days. I use what SMR
refers to as its "solid line" for a short-term
indicator of price momentum. I prefer to call this
indicator the "short line" or "SL." (Note: In my
first book, Intelligent Futures Trading, I called this line the "Timing Line" since
it is used primarily
for shorter term timing; however, "short
line" or "SL" is simpler.)
SMR's short-term momentum oscillator is constructed
by taking about a two-, three-, or fourday
moving average of the closing price and subtracting
around a nine-, ten-, or eleven-day
moving average of the closing price. Subtracting one
number from the other will produce
either a positive or negative number (and
occasionally zero). Then, as mentioned above, simply
connecting the "dots" (i.e., each day's
oscillator number) on a chart will produce a line that
oscillates above and below zero.
The shorter the two time periods used to construct
this type of oscillating moving average, the
more directly connected the line will be to the
movement of the daily price. Therefore, a "2/9"
line—using a two-day moving average of the closing
price minus a nine-day moving average—
will be more sensitive, move up and down more
quickly, than a "4/11" line. A 2/9 line will be
more sensitive to price moves but more erratic in its
movement. A 4/11 line will be less
sensitive but less erratic (i.e., change directions
less often). And naturally, a 3/10 line
would fall somewhere in between.
THE INTERMEDIATE-TERM MOMENTUM INDICATOR
An intermediate-term momentum indicator needs to be a
reasonably reliable measurement of the
price energy flow of the past few weeks. I use SMR's
other proprietary line for an intermediateterm
momentum indicator. SMR calls this line their
"dotted line," or DL; I refer to it as simply the
"middle line," or "ML." (Note: In
my first book I called this line the "Confirming Line" since it's
used to confirm signals, but "middle line,"
or "ML," is simpler.)
SMR's intermediate-term momentum line (ML) is simply
a smoothed out (around three weeks, i.e.,
15-, 16- or 17-day) moving average of their
short-term oscillator (the SL). Since this middle line, or
ML, is a moving average of the short-term oscillator,
it too will oscillate above and below zero.
As stated earlier, the specific formulas and
techniques used to create trend/momentum indicators
are not overly important, as long as the resulting
lines are reasonably reliable. Any number of
different trend/momentum indicators could be created
using the above formulas as starting
points, and almost any of them would be effective
enough for successful trading—as long as they
were reasonably reliable (like SMR's are) and you
became familiar with their tendencies.
For example, for those who like to work with stochastics,
renowned trader Linda Rashcke, a longtime
subscriber to SMR charts, describes in her book Street Smarts (co-authored with Laurence
Connors and published by M. Gordon Publishing Group)
a stochastic formula she states produces
momentum lines whose movements are very similar to
SMR's momentum oscillators. The
stochastic formula she gives is "7%K and
10%D." (I assume anyone who is familiar with stochastics
will understand this formula and know how to
construct it on charting software.) However, I am
not a fan of stochastics as find it has some serious
limitations (mainly its upper and lower limits,
which tend to keep traders out of sustained moves). I
find SMR's momentum indicators to be far
superior to stochastics as well as other momentum
formulas I have encountered, and so naturally I
prefer to stick with their indicators.
Of course, if a trader so desired, he or she could
use any trading software program and construct
trend/momentum lines covering many more time frames.
Momentum indicators can be constructed
covering anywhere from minutes to years. My
preference, and recommendation, is to keep it
simple: Subscribe to the SMR Charts and then update
them daily from their Web site. Over many
years of trading I have learned that for the
individual trader, clear, simple, and direct invariably
works best. Getting the charts and daily data from
SMR is the clearest, simplest and most direct
way to obtain reasonably
reliable trend/momentum indicators, as well as quality charts.