Thursday, April 30, 2009

Building a Stock Market Indicator of Momentum and Strength

Over the years, I've developed quite a few indicators, some of which (such as my volatility-adjusted pivot/target levels and the Demand/Supply measure) I post daily to Twitter.

The process of developing an indicator generally begins with an idea and then proceeds with various riffs on that idea. Sometimes this playing with data leads to something unique; most of the time, it doesn't.

I thought I'd share my first approximation of an indicator. This tracks the 20-day average of the number of "strong days" in the S&P 500 Index (SPY). To qualify as a strong day, a day must close in the top half of its daily trading range.

So this is a kind of oscillator to see if stocks tend to finish the day above, below, or at the day's estimate of value (average trading price).

When the number of strong days is above 10 and rising, we have a market in which traders are tending to buy intraday weakness. When we have the number of strong days below 10 and falling, we have a market in which traders are tending to sell intraday strength.

My hypothesis is that momentum leads price: the proportion of strong days should peak and trough ahead of price, as rising and falling markets lose steam and, as moves age, fail to pick up intraday buyers/sellers.

In future posts, we'll take a look at tweaking this very simple measure.

5/1/09 - Thanks to the Total Negative Slack blog for programming the above indicator.