Long-term, medium-term and short-term indicators

We incorporate three momentum indicators to track the three investment horizons as discussed on page 10. The monthly or long-term momen- tum indicator tracks the long-term trend, roughly a 10-month rate-of-change). The weekly, me- dium-term or intermediate-term momentum in- dicator (roughly a 10-week rate of change) tracks the medium-term trend while the daily or short- term momentum indicator (roughly a 10-day rate of change) tracks the short-term trend.

We then combine the momentum indicators with the moving averages to identify the trends in force and to assess the most likely future path of these trends.

The highest investment return is achieved when investors start buying at the momentum bottom and add to positions when the price confirms the momentum indicator´s uptrend and rises above the

moving average. Likewise, investors should start selling if the momentum indicator tops out and sell more if the price falls below the moving average. Thus, a combination of the signals given by the momentum oscillators, moving averages, and support and resistance should be applied.

Trend and momentum combination

On page 15, we pictured the three moving averages on one single chart which was the daily chart. We do the same analysis here with the momentum indicators. We show all three momentum indicators on the daily chart together with the short-term, medium- and long-term moving averages.

On the chart above for the US dollar/Swiss franc, the long-term trend was rising from 1996 until August 1997. The US dollar was trading above the rising 144-day average and the long-term momen- tum indicator was rising until it topped in September. The momentum indicator´s top was soon con- firmed by the dollar´s fall below the 144-day average in September and October. The long-term top was also indicated by the negative divergence (dashed blue line) in the medium-term momentum indicator, which registered a lower high in September compared to its high in March. Thus it did not confirm the new price high in the US dollar at CHF 1.54 in August.

The medium-term trend was bullish from September 1996 until March 1997 when the weekly indica- tor topped and the US dollar fell below the slowing 55-day average. The medium-term top in March was also indicated by the negative divergence of the daily momentum indicator, which did not confirm the new high in the US dollar in February 1997 at 1.49. The daily indicator registered a top that was lower than the top in January.

THE COMBINATION OF THESE SIX INDICATORS reveals the most likely future path of the underlying market in all asset classes. The 21-day average is monitored in combination with the daily (short- term) momentum indicator, the 55-day average with the weekly (medium-term) indicator and the 144-day average with the monthly (long-term) momentum indicator.

The most positive technical constellation is present when the price is above the short-term average, which in turn is rising above the medium-term average, which in turn is rising above the 144-day moving average. AT THE SAME TIME, the daily, weekly and monthly momentum indicators are rising. The same is true in the opposite direction for the most negative constellation.

Reversal and redistribution

IBM is shown above together with the medium-term momentum indicator on the weekly chart. Sig- nals are given when the trend reverses an extreme lev

els. The stock is said to be OVERBOUGHT when the momentum oscillator reaches an extreme upper level above the zero line and OVERSOLD when it reaches an extreme lower level below the zero line. The oscillator acts like a rubber band: the further it stretches, the more the prices need energy to sustain the trend, i.e. a trend reversal should be expected the more stretched the mo- mentum indicator becomes.

Sometimes signals leave room for interpretation (tech- nical analyis is an art not a science). The indicator does not always cross the zero line before giving a new buy- or sell signal. These signals are called redistribution ex- amples (see scheme on the right and chart above) or re-accumulation.

Sometimes, the oscillator turns upwards again from a high level above the zero line instead of bottoming below the zero line. This is seen as a high-risk buying opportunity. Most of the time the ensuing price rallies are short-lived and are, more often than not, fully retraced. The same pattern can occur in the opposite direction when the indicator turns downward again from a low level below the zero line (still oversold) instead of topping above the zero line (overbought level).

This is seen as a high-risk selling opportunity. Most of the time, the ensuing declines are short-lived and are, more often than not, fully retraced.

The pause and delay in the aberrated trend is often psychologically quite unnervingfortheinvestor. Therefore, patience becomes a tactical requirement, allowing the major underlying trend forces to rebase at the adjusted price level.

Portfolio analysis

Each day we calculate the position of over 1000 stocks on the short-, medium- and long-term momentum model. Four stocks are shown on this page, each displaying the medium-term in- dicator in one of the 4 possible positions. In- vestors should look to buy stocks with a rising momentum indicator while selling the stocks with a falling momentum indicator.

On the previous page, we pictured 4 stocks and their weekly momentum indicators. If we take 30 stocks in- stead of only 4 and calculate the medium-term indicator for each of the 30 stocks, we can calculate the number  of stocks positioned in each cycle quadrant.

The example above shows the 30 stocks in the Dow Jones Industrial Index. For each stock, we calculated the position of the long-term, medium-term and short-term momentum indicators. On the right, we highlight the dis- tribution of the medium-term indicators from the table above. The distribution shows

5 stocks (17%) with a momentum indicator rising       below the zero line (up).

16 stocks (53%) with a momentum indicator rising above the zero line (advancing).

7 stocks (23%) with a momentum indicator falling above the zero line (down).

2 stocks (7%) with a momentum indicator falling below the zero line (terminating).

Thus, the entire portfolio of 30 stocks equals 100%. We use percentages so that we can compare different portfolios and markets with different stocks and different asset classes.

The same percentage distribution is shown above for the long-term indicators and the short-term indicators. From this data, we can see that, as of this point in time, the 30 stocks were quite advanced in their intermediate-term uptrend (a+d=76%; see page 17 for cycle phases). Moreover, the long- term analysis shows that most stocks were in the bearish phase (d+t=70%). Only the  short-term  cycle pointed to strength (u+a=63%).

We do this type of momentum analysis for over 1000 stocks, 80 stock market indices, 40 commodi- ties, bond-futures and 40 interest rate series. Also, for the US dollar against 40 currencies and the same for the Japanese yen, euro, Swiss franc and British pound each against 40 currencies. We  search for those financial market series that are best positioned in bull phases. The indicators provide a clear outlook and objectivity for the broad market trends, allowing you to buy and sell against the backdrop of subjective emotional stress.

You need to build trust in these indicators so that you can buy against the prevailing pessimism and sell against the prevailing optimism.