Monitoring Market Momentum With A Set Of Moving Averages
James Picerno | Nov 18, 2014 07:19AM ET
The momentum factor in asset pricing is widely recognized and respected, but there’s nothing close to consensus on the best definitions for what is arguably the most durable “anomaly” in the markets. A quick review of the voluminous literature on the subject reveals a variety of methodologies—absolute vs. relative momentum or price-based vs. return-based strategies, for instance. But the common theme that unites all definitions and strategies in this space is a focus on trending behavior for short- to medium-term horizons. Although minds will differ on the ideal for measuring and exploiting this phenomenon, a reasonable way to begin is by comparing an asset’s latest closing price to a variety of simple moving averages.
Why several moving averages? Because no single trailing period rises to the high standard of dispensing relevant insight for all assets under all macro and market conditions at all times. The good news is that at least one facet of the momentum game is enduring and universal in the all-important business of looking for turning points and/or confirming the current trend. When positive momentum is giving way to its negative counterpart, a recurring pattern unfolds: short-term moving averages break down, eventually leading to a progressive series of reversals in the longer-term measures. The same holds true in reverse when negative momentum is transitioning to positive momentum. Similarly, when a spectrum of moving averages are aligned, that’s a strong signal that tells us that the current state of momentum is strong.
These historical lessons inspire monitoring momentum via a series of moving averages for perspective on a market’s current state. But it’s best to show rather than tell. Here are three examples using ETFs for US stocks (SPDR S&P 500 (ARCA:SPY)), foreign stocks in developed markets (iShares MSCI Eafe Index Fund (ARCA:EFA)), and emerging market equities (iShares MSCI Emerging Markets (ARCA:EEM)) with closing prices as of yesterday (Nov. 17). Each graph shows the percentage difference between the closing price vs. five moving averages, ranging from a 10-day average up to a 200-day average. For additional perspective, the spreads are shown for each of the past five days, with the most recent data (yesterday’s close) shown by the red bars.
First up is the US stock market via the SPDR S&P 500 ETF (SPY). As the chart shows, positive momentum is currently strong for US equities. Yesterday’s closing price is comfortably above all five moving averages (MAs). Note the progressively higher spreads for the longer MAs—a tell-tale sign that trailing momentum has been bullishly positive. At some point this will reverse, of course, and the change will unfold in the usual way: the short MAs will turn negative first, followed at some point by reversals in the long MAs.
Get The News You Want
In contrast with US stocks, negative momentum characterizes foreign equity markets — iShares MSCI EAFE (EFA) — in the developed world (mainly Europe and Japan), as shown in the next chart. The return of positive spreads in the short MAs lately suggests the potential for a bullish reversal, although for the moment it’s unclear if this is just noise or the start of a genuine change. But if the longer-term MAs show upside movement in the days and weeks ahead, it may be time to reassess the outlook for EFA.
Meantime, negative price momentum continues to dominate emerging-market stocks – iShares MSCI Emerging Markets (ARCA:EEM). As of yesterday’s close (red bars), EEM’s trading below all the MAs.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.