Finding New Momentum Highs or Lows

Sep 17, 2007: 12:33 AM CST

In my trading, I frequently utilize strategies that are dependent upon an initial condition that arises from a new momentum high or low.

The basic market principle that I derive these strategies is stated as “Momentum Precedes Price,” indicating that when a new momentum extreme is reached, a new price extreme in that direction is more likely to occur than not.

The “Impulse Buy” and the “Impulse Sell” trade have their roots in this basic market principle, and are identified by specific momentum readings.

Imagine momentum as a temporary supply/demand imbalance where one side of the market temporarily dominates the other side. The imbalance highlights the underlying condition that one side will likely continue to dominate the other side, at least in the short term, which can set up high probability trade ideas.

It must also be stated that there will (almost) always be a reaction against that momentum move, and it is your job as a trader to enter positions in the direction of the impulse, following the expected retracement.

So, if momentum readings are so important, how might we discover them easily?

In truth, there are various ways you can identify the impulse or momentum condition through oscillators, or by price alone.

Gaps can serve as an initial impulse, indicating a temporary imbalance in supply and demand that will soon resolve itself. Gap identification is the easiest way to identify the momentum condition.

You often cannot use traditional indicators (like the Stochastic or RSI or CCI) in the default setting to highlight momentum highs (or lows).

For this example, I am using the following:

  • 3/10 Oscillator, Created by LBR Group and used by Linda Raschke,
  • Rate of Change (ROC) taken down to a 5 period lookback (default is usually 14)
  • “Force” Index in StockCharts.com with 14 period lookback (shorter is better, however)

Let’s review two “New Momentum Highs” and subsequent higher price highs (as expected) in eBay:

If this chart appears complicated, I apologize. Let’s start at the top and move down.

In the middle of July, price makes a new momentum high but not a new (relative) price high. Odds still favor higher prices are yet to come, after a pullback, or reaction against the new price swing (which began in early June and ceased in early July).

It would have been proper to enter a long (buy) trade at this pullback, depending on how you define pullbacks.

The “Pure” New Momentum High occurred in mid-August, with price making a new high AND all three indicators making new swing highs (new relative peaks).

This indicated that momentum was strong in the market, and new price highs are yet to come. We get the normal and expected reaction, allowing us a chance to put on a new long (buy) trade and anticipate a new price high, based on the recent significant new momentum high in the oscillators.

I have drawn two purple vertical lines to highlight the New Momentum Highs.

I have drawn horizontal slashed purple lines on the oscillators to highlight the New Momentum (oscillator) Highs.

Train yourself to recognize these conditions, and you will be able to see Momentum Impulses. Perhaps the Force Index and the ROC indicators will be the easiest to highlight these conditions, yet I use the LBR 3/10 Oscillator because of the various pattern recognition, as well as trend condition recognition parameters inherent in the oscillator.

Momentum Precedes Price. Use your oscillators in a new way to uncover what the market is telling you about the current balance – or imbalance – between buyers and sellers and what that might mean for the near future (and how you can capitalize on it!).

5 Comments

5 Responses to “Finding New Momentum Highs or Lows”

  1. Jonathan Says:

    Good explanation and example. I like how you are consistent in the use momentum. Thanks for sharing the details on how you make it work.

  2. El Says:

    Thanks for the detailed explanation. I have two questions:

    (1) whether there was a momentum high or not is a function of your time-period (whether you consider readings within 3m or 1yr makes a significant difference). Do you have a preferred time span?

    (2) could please you talk a little more about the reaction to a “new momentum high”? e.g., what constitutes a normal pullback in terms of time and % loss?.

    Thanks again!

  3. Corey Rosenbloom Says:

    Thank you, Jonathan.

    El,

    1. You’re right – momentum indicators are absolutely relative to the time frame you are viewing. A new momentum high on a 5-minute chart is a much smaller target than the same on a daily chart. When I am actively trading intraday, I like to use the 5, 15, and 30 minute charts and use the parameters there. I am playing for small targets only. For analysis and setting up the big picture, I’ll almost always use daily charts only. I rarely make decisions off weekly charts.

    Smaller time frame momentum precedes larger time frame momentum. And, of course, the longer the time frame reading, the more valid (but less frequent) the signal. I prefer the dailies.

    2. You don’t want to enter a position right when you identify new momentum highs, because the move is ending or already up. You want to identify them, note them, and then wait for a reaction against them before entering for a higher probability trade. Often, the initial target is a retest of the price highs ONLY, but sometimes I take off half the swing position at the retest zone and play ‘with the house money’ with the other half of the position.

    It is up to the individual trader – depending on risk levels and tolerance – to define what a proper retracement is. I didn’t show them on the chart for simplicity, but I will simply use the rising (or falling) 20 period exponential moving average to enter the balance of my position for a swing trade on the dailies. More sophisticated traders can use Fibonacci retracement zones against that new price high, but I do not. Sometimes you can even use a “1/2” or a 50% retracement as acceptable, but I find the 20 period EMA more visually appealing and faster to calculate (the zone) if you’re looking across many stocks for the highest probability play out of a filtered watchlist.

    In addition, the 20 period EMA gives you a clear stop-loss risk point, relative to the recent price high you are playing to achieve.

    Also, a downswing (or counterswing) against an uptrend (such as in eBay above) should never take out the most recently established swing low. If it does, it invalidates the structure of the uptrend temporarily. In a word, the reaction went too far. I won’t trade those instances to the long side following the observed momentum high.

    I want to see a proper retracement fit into the swing structure of the market, and if the swing takes too much time to complete, I’ve been known to scratch the position for a small loss early. I tend to know when something isn’t working out based on previous experiences and expectation, but then again I’m more risk-averse.

    I don’t expect to see consolidation of price following new momentum highs, but rather an orderly pullback and then a play (trade) to the upside. If it doesn’t work out, the risk point is very close to entry, and I’ll usually scratch after 4 to 7 days (on a swing trade) if nothing happens. Your best trades happen quickly, with a lot of traders seeing the same setups and structure. Keep in mind, nothing is 100%. We’re just trying to work with greater odds and probabilities only.

    Thanks for the questions!

  4. Glyn Says:

    Great call on BBY – almost to the penny. I guess this week will bring the volatility back – Euro and Aisa markets struggling to find confidence in the financial sectors – I guess the lack of confidence banks have with each other is spreading to the investor. IBM looking good – further downside?

  5. Corey Rosenbloom Says:

    Hey Glyn,

    It’s always fun when technical analysis works as planned. 🙂 BBY hit its bottom trend channel and suddenly bounced up.

    You’re right – we’ve seen stark consolidation and the Fed meeting has the potential to blast us out of the dull days we’ve had. People were waiting for Tuesday’s action.

    I don’t know if IBM has further downside. It has pulled back as expected from a ‘double top’ pattern – or at least overhead resistance – and has (maybe) found support at the (near) convergence of the 20 and 50 period moving averages. Odds would favor that those zones would serve as support… until proven otherwise. I think we may consolidate or perhaps make a new leg up.

    If you want to go for a long trade, here may be a choice spot. At least your risk would be defined by a stop below $112, entry near $114, and target $120. That’s a 3 to 1 reward to risk – not bad.