Perhaps it is because we just got to the end of the first, very exhausting, week in 2021. Perhaps it is because the market rose too far, too fast. Perhaps, even with the big move higher, uncertainty lies beneath the surface. Or perhaps for all of these reasons, the momentum chart (bottom) shows a divergence with the S&P 500’s price chart. (top).
First, a word about momentum.
Momentum can detect trends well before price does, therefore as a tool, it alerts you to a trend shift well before the crowd. Momentum, when it diverges from price, can spot reversals in trends. Many, including us at Marketgauge.com, use moving averages. However, often the simple daily, weekly, or monthly moving averages are not respected. The price might move beyond those averages, which as a result can become the more important level.
We have created a momentum indicator called ‘Real Motion’. We use this indicator for early detection of breakouts/breakdowns. The early detection helps you see what might happen to the price before it crosses over or under major moving averages.
On the chart, the top is the price action of the S&P 500 as of Friday, January 8th. The blue line is the 50-daily moving average, and the green line is the 200-daily moving average.
Below the price chart, I show you the momentum chart. And our Real Motion indicator. The moving average of price is plotted as the zero line or baseline (the black horizontal line.)
The dots are a ratio of current price divided by the average of price. The blue line is the fast-moving average of the real motion ratio, and the green line is the slow line or long-term average of the ratio.
Note the dots from early December on the bottom of the chart, or the momentum chart. At that point, the momentum was gaining and reached a high. Now look at the pure price at the same time. The high that day was at 369.85.
If you move to the right and consider current price action, look at the high close on January 8th. The price high is 381.72. Now, look at the momentum chart. The dots are lower than the peak momentum day in early December. Yet the pure price is higher by $13.00.
Does this mean anything yet?
We will watch the dots carefully as this could give us a sign momentum is waning while price is rising, which would raise some flags as to the longevity of the current Bull Run. But we do need some confirmation. Should the dots break the blue line and the low from January 4th, that will give us a bona fide signal of divergence between price and momentum.
From there, we will watch to see if the price falters. And most importantly, we will watch the 50-DMA on the pure price chart.
Should we see both momentum and price go below their respective blue lines, then the current euphoria will clearly shift to caution. Or at the very least, it will give us a reliable sign that either a top is in, or we are overdue for a healthy correction.
Michele 'Mish' Schneider currently serves as Director of Trading Research and Education at MarketGauge.com. She writes and produces daily market analysis in "Mish's Daily", and serves as a developer and trading mentor in several of our trading services, drawing on her 30+ Years of Trading and Teaching Experience.
Mish is a former floor trader on several New York Commodity Exchanges, including Coffee, Sugar and Cocoa NYMEX and FINEX in NYC. While on the trading floor Mish also served as a market analyst for two of the largest commodity trading firms at the time - Continental Grain, and Conti-Commodities.
Mish also wrote the best-selling finance book, Plant Your Money Tree; A Guide To Growing Your Wealth.