Dr. Market Edge Says

Back to Education Institute

Market Timing – The Momentum Index
The Momentum Index measures positive and negative divergence in the market.

The Market Edge 'Market Letter' combines three proprietary market-timing index’s into a computer model which attempts to forecast the intermediate term direction of the market as measured by the Dow Jones Industrial Average (DJIA). These index’s are the Cyclical Trend Index (CTI), the Sentiment Index and the Momentum Index. The collective readings from the three index’s form the Market Posture which can be either bullish, bearish or on rare occasions neutral.

The Momentum Index is designed to measure the market's positive or negative divergence by comparing the relationship of nine broad market indexes to that of the DJIA. Measuring divergence is an important tool when attempting to project the market's future direction. In addition, the index tracks five breadth indicators which measure the broadness of market moves. Each of these indicators is assigned a +1, 0 or -1 value based on its bullish, neutral or bearish connotation. Positive numbers are the result of an index outperforming the DJIA on a percentage basis when compared to the index’s previous cyclical low or when an index declines less than the DJIA when compared to the index’s previous cyclical high (positive divergence). Negative values occur when an index underperforms the DJIA when compared to the prior lows or when an index declines more than the DJIA when compared to the prior highs (negative divergence). Readings over +3 are regarded as bullish while readings under –3 are deemed to be bearish. The Momentum Index is updated weekly and is located at the top of the Market Edge “Market Letter”.

The following is a description of the various indicators and studies included in the Momentum Index.  

Momentum Index:	+7		Positive
Momentum Index Components	Current Reading	Prior Week	Connotation
**Dow Jones Industrial Averages (DJIA):	10543.22	10592.21
**DJ Transportation Average	3686.03	3726.74	Positive
**S&P 500 Index	1188.00	1191.17	Positive
**NYSE Composite Index	7028.51	7092.62	Positive
**NYSE Advance-Decline Line	51838	52772	Positive
**10 Day MA Advance-Decline Line	0.97	1.19	Negative
**AMEX Index	1392.08	1415.58	Positive
**NASDAQ Composite Index	2128.07	2147.96	Positive
**DJ Utilities Index	319.69	319.68	Positive
Trin (5 Day Average)	1.19	0.98	Neutral
NYSE Weekly New Highs-New Lows	834-36	604-23	Positive
Zweig Breadth Indicator	0.55	0.63	Neutral
McClellan Oscillator	86	9	Neutral
McClellan Summation Index	4314	4807	Positive
Unchanged Issue Index	0.05	0.04	Negative

**Connotation denotes Positive or Negative Divergence from the DJIA

Divergence is a technician's term that describes whether the DJIA is performing better or worse than the majority of the other market indexes. Whenever the DJIA goes its own way or diverges from the broader market indexes for a period of time, whether up or down, a market turn is usually at hand. Bearish divergence occurs when the DJIA makes a new cyclical high and the majority of the other indexes do not. Conversely, bullish divergences occur when the DJIA makes a new cyclical low and the majority of the other indexes do not. When the DJIA makes a new high or new low and the majority of the other market indexes are doing the same, the DJIA’s move is said to be confirmed. On the other hand, a new cyclical high or low recorded by the DJIA accompanied by diverse moves by the majority of the other indexes is referred to as a non-confirmed move.

The following index’s are tracked and compared to the percentage movement of the DJIA in order to spot either positive or negative divergence.

      Dow Jones Transportation Index (DJTA)
      S&P 500 Index (SP-500)
      New York Stock Exchange Composite (NYSE)
      NYSE Advance-Decline Line (A/D)
      10 Day Moving Average of the NYSE Advance-Decline Line
      American Stock Exchange Index (AMEX)
      NASDAQ Composite Index (NASDAQ)
      Dow Jones Utilities Index (DJUI)
      NYSE Weekly New Highs-New Lows

Breadth indicators measure the broadness of a market move. A healthy market exists when more issues are advancing than declining and volume on up days exceeds the volume on down days. The following indicators are incorporated into the index to monitor these conditions.

      Trin (5 Day Moving Average Of The Arms Index)
      Zweig Breadth Indicator
      McClellan Oscillator
      McClellan Summation Index
      Unchanged Issue Index

The Momentum Index is a reliable tool in spotting significant trend reversals. The Dow Jones Industrial Average is a weighted average of thirty blue chip stocks. It is the most widely followed equity index in the world and is the standard measurement of the health of the US equities markets. Since the DJIA only contains thirty stocks, its performance can mask the underlying strength or weakness of the market as a whole.

Typically, a significant DJIA move is accompanied by a series of confirmed highs or lows which occur over an extended period of time that can last up to 3 years. During a bull phase, positive values from the Momentum Index confirm the move as long as the DJIA’s new highs are matched by the broader indexes. When the DJIA makes a new high which is not confirmed, the index will turn negative signaling a reversal of the trend. Conversely, during a bear market, negative values indicate that the DJIA is making confirmed lows. The Momentum Index will remain negative until such time that the broader indexes begin to outperform the DJIA by either moving up or declining at a slower rate. At that point, the Momentum Index will begin to generate positive values suggesting an end of the bear phase.