Technical analysis is one of the main trading disciplines that any investor can use to boost their returns. Although it can seem daunting at first, mastering the art of technical analysis is not all that difficult. You need to develop an interest in analyzing statistical trends to identify price-movement trends and volume trends. And before you know it, you can utilize all the tips and tricks in this article and practice momentum investing on your own.
Before we start, though, you have to keep in mind that any stock strategy can fail. That’s why we continue to research new ways to pick stocks and why it’s a never-ending learning curve. Things like the novel coronavirus pandemic, which wiped nearly $5 trillion off the markets, cannot be predicted. The best thing you can do is keep learning and have your ear to the ground. We can help you in that regard with our series of “How to Invest” articles.
So, with that out of the way, here are five momentum metrics that you can use to power up your portfolio:
Momentum Investing Metrics: Rate of Change (ROC)
Let’s start with something that is a relatively simple concept. The rate of change, or ROC, is how a variable changes over a specific period of time. For instance, let’s say you are mapping the change in price for a particular security. You can do that, as an example, using the following formula: Rate of Change = [(Current Value of Stock/Previous Value of Stock) – 1] * 100.
You might be wondering, “Well, what’s the big deal?” It’s a simple ratio that expresses the change between one variable and a corresponding change in another. And while you are not wrong in that the calculation is simple, you would be incorrect assuming that it’s not a useful measure of momentum investing.
When a security has high momentum, it will have a positive ROC and beat the market. Vice versa, when a stock has low momentum, it will have a negative ROC, servicing as an indicator to exit your position.
Relative Strength Index (RSI)
One of the most commonly used indicators in momentum investing is tracking the current and historical strength or weakness of a stock or market based on a recent trading period’s closing prices.
The metric tracks the gains or losses that occur over 14 trading periods. It uses a bounded range value of zero to 100 to mark overbought or oversold conditions in the stock price.
Values that are 70 or above indicate overbought security, whereas values of 30 and below show an oversold condition.
The 50-Day and 200-Day Moving Averages
Some trading strategies are simpler than others, but that doesn’t make them any less effective. A moving average calculates the average share price over a certain number of days. When outlined on a chart next to the share price, it smooths out the volatility of day-to-day and week-to-week movements to show you the general trajectory of a stock. Several investors have a thumb rule, which says that they will never open or expand a stock position if the share price is not trading above the 200-day moving average line.
There are also several trading cues that you can obtain by observing the moving averages. For instance, if the 50-day moving average crosses above the 200-day moving average, then it’s an indicator to buy, while if the two lines intersect cross below, it’s an indicator to short the stock. You can obviously use these techniques with a moving average with a longer time horizon to take further cues.
One-Year (1Y) and Six-Month (6M) Relative Strength
Not to be confused with the relative-strength index, relative strength shows the difference between the price movement versus the price-movement market over a time period. This is useful because when the stock value falls, you can see it as an indicator to sell.
However, relative strength can be favorable even if the stock has fallen, as long as the market has fallen even further. Therefore, absolute price movements can be contradictory to this analysis, which aims to pick all-weather performers among a field of stocks.
The Coppock Indicator
We polish off this list with a somewhat peculiar stock-picking method. The Coppock Indicator is a long-term momentum indicator used to assess when a new bull market will begin. Economist Edwin Coppock concluded that market downturns led to a period of mourning in investors. And so, he asked a priest how long mourning usually took. The priest said the bereavement period usually lasted between 11 and 14 months. Hence, Coppock came up with an indicator based on the sum of 14 months and 11-month rates of change of the S&P 500 smoothed by a 10-period moving average.
Surprisingly, the indicator turned out to be quite accurate. But as is the case with most entries on this list, you should use various indicators to pick stocks to minimize risk.
On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. Faizan has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. Faizan does not directly own the securities mentioned above.