Sunday, March 15, 2009

Demand and Supply: Measures of Stock Market Momentum

Probably the most unique and unusual indicator I track is a proprietary measure called Demand and Supply. These measures are not available in the public domain to my knowledge; I do, however, track them each morning before the market open in my Twitter posts (free subscription here).

We can think of Demand and Supply as momentum measures: Demand taps significant upside momentum, Supply captures significant downside momentum.

Significant momentum is defined by a stock's closing above or below its Bollinger Band; i.e., above or below the volatility envelope surrounding its short-term moving average. The larger the number, the greater the number of NYSE, NASDAQ, and ASE stocks that are trading with significant momentum.

This is useful in identifying market turns (as strong momentum turns to weak momentum before reversing), and it's useful in identifying markets with considerable thrust that are likely to follow through in the short run.

In the chart above, you can see how Supply (yellow line) peaked well ahead of price and how it petered out prior to the market rally. We can also see Demand (pink line) soar early in the rally, suggesting considerable upthrust.

I'll be posting more regarding applications of this unusual indicator. For instance, when both Demand and Supply are low, we tend to have a range market. Pullbacks in Demand and bounces in Supply represent good swing entry points in trending markets. A cumulative line of the difference between Demand and Supply is the best overbought/oversold indicator in my arsenal. (Note: it is updated each Monday as part of my indicator review; tomorrow's Cumulative Demand/Supply Indicator posting is particularly interesting). When a period of strong Demand is followed by a spike in Supply (as in the second week of February) or vice versa, we typically see a trend change.

The core idea behind Demand and Supply is that momentum tends to top and bottom ahead of price. Again, I will be posting much more on this topic later in the week.