A Momentum Analysis Of The S&P 500

10/08/10 09:25:23 AM

by Alan R. Northam

Price looks like it could continue to chug along, inching its way upward. A look at momentum suggests otherwise.

Security: SPX
Position: N/A

Over the last three months, the Standard & Poor's 500 has been trading upward in a narrow 110-point trading range as shown in the second window of Figure 1. As can be seen, price moved up toward the upper channel line in mid-September and has been trading parallel to this upper channel line ever since. Over the last three trading sessions, price has moved slightly higher and is now touching this channel line. Now, will price break out above this channel line, or will the channel line act as a line of resistance and ultimately turn price back down? To answer this question, we will take a look at the long-term, intermediate-term, and short-term momentum indicators.

The upper panel of Figure 1 shows the long rate of change (ROC) indicator. This indicator takes the difference of the most recent closing price and subtracts the closing price of 200 days ago from it and plots the difference. When the indicator line is moving upward, it indicates price acceleration and when it moves downward it indicates price deceleration. From this chart we can see that the long-term momentum indicator is bounded by an upper channel line and a lower channel line that is approximately 110 points wide. This same channel is seen on the price chart in the second window. Note that from late August to mid-September this momentum indicator remained above its primary trendline. In addition, in mid-September this long-term momentum indicator broke down below its primary trendline and started to trend upward at a much shallower slope as noted by the secondary trendline. This indicates that the upward price momentum is slowing down. This slowdown suggests that this momentum indicator will not break out above its channel line. With momentum up against its upper channel line and the fact that upward momentum is slowing also suggest that its next step is to turn back down and retreat to its lower channel line. If momentum continues to slow down and ultimately turn back down, we need to look at some shorter-term versions of this momentum indicator.

FIGURE 1: SPX, DAILY. Here's the S&P 500 in the second panel, the long-term momentum of price in the top panel, the intermediate-term momentum indicator in the third panel, and the short-term momentum indicator in the bottom panel.

Graphic provided by: MetaStock.

Panel 3 shows price momentum over a 50-day period. This momentum indicator takes the current closing price and subtracts the closing price of 50 days ago from it and plots the difference. In this panel that the intermediate term momentum indicator remains in an upward trend that started in early July. However, from mid-September the intermediate-term momentum indicator has been moving sideways. This is an indication that momentum over the intermediate term is neither moving higher nor lower. In a healthy uptrend the momentum of price should continue to move upward. Thus, this sideways movement of the intermediate-term momentum indicator is suggestive that the long-term momentum indicator will continue to move between its secondary trendline and the upper edge of its horizontal boundary line. This further suggests that price will continue to move slightly higher as it continues to trade along the upper boundary line of its trading channel.

Looking at the bottom panel I see a weakening of momentum. This panel shows the 20-day short-term momentum of price. Note that this short-term momentum indicator is bounded by a horizontal channel that is approximately 180 points wide. Note that the short-term momentum of price has broken down below its upsloping trendline and is moving downward. This is an indication that price is decelerating over the short term. It is therefore expected that price will continue to move lower towards its lower channel line. If the short-term momentum indicator continues to move lower, it suggests that the intermediate-term indicator of momentum will turn down as well. And since the short-term momentum indicator has 130 points to fall, the intermediate term momentum indicator could break down below its lower trading channel line and even break down below its primary trendline.

In conclusion, the long-term momentum indicator is up against its upper boundary line, the intermediate-term momentum indicator is moving sideways, and the short-term indicator of momentum is starting to move lower. All this may suggest that price is ready to turn down and head toward the lower boundary line of its trading channel.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.