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Momentum – like a rolling stone

June 7, 2016
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As featured in the Herald Sun – Friday 3rd June 2016.
By David McCulloch – Market educator and consultant to Share Wealth Systems

Momentum as it exists in nature is a combination of mass and speed. We would all be familiar with the image of a snow ball at the top of a snow covered hill being pushed by a small child. Initially the child might struggle to get the snowball rolling as a degree of inertia has to be overcome. The child pushes and finds it too difficult to budge the snow ball and elicits the help of their friends. At last the dense ball of snow makes its way down the slope, gathering more snow (mass) and moving faster and faster (speed). Momentum is now building and is something that now underway is difficult to stop.

Momentum also exists in the markets and it effect can be equally as significant. When discussing momentum we typically refer to internal momentum and compare the speed or change in speed (rate) over a period of time. So what is it that creates the initial movement and subsequent increase in speed over that time, and how long might it last? In the world of technical anlaysis the most relevant indictor to measure momentum is the Relative Strength Index (RSI) which basically measures the number of “up” days compared to the number of “down” days over a specific look back period. Common look back periods are 10 market days (half a month) or 21 market days (one month). The RSI is another oscillator type indicator with settings between 0 and 100. Values above 70 are generally referred to as overbought, and values below 30 oversold.

Traditional use of the RSI would suggest that buying a stock as its RSI moved towards 70 may not be a good idea because it has been overbought. I personally don’t like the “overbought” concept because it suggests that the stock will struggle to keep moving upwards. Momentum as being measured by the RSI is increasing, and as in nature can continue for long periods. What’s creating that momentum?

Price is the culmination of everything that is known about a particular stock at any point in time, and if price is continuing to build momentum it suggests that something bigger may well be at work. How long that will continue for is anyone’s guess but as in nature, once momentum gets underway it can be difficult to slow. One thing is for sure and that is that the market has decided to get behind this snow ball and give it a “push”. The mass will get larger only if there is more demand than supply and from a technical point of view that’s what we are looking for.

There are many stocks that have had extremely long periods of steady momentum over the years. Ramsay Health Care (RHC) is one prime example. Some have had shorter bursts of momentum like Blackmores (BLK). In both examples momentum carried the stocks a lot further than you may initially have thought. With Winter upon us, maybe it’s time keep an eye out for “snow balls”.

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