Trends hint there's a bear in there

Looking at the progression of an index or stock price in isolation does not give investors a lot of information about the nature of its progress. So this week we introduce the momentum indicator.

Looking at the progression of an index or stock price in isolation does not give investors a lot of information about the nature of its progress. So this week we introduce the momentum indicator.

The chart - produced by Robert Brain, a member of the Australian Technical Analysts Association - shows the weekly trajectory of the All Ordinaries Index against its momentum indicator. If a market is rising and the amounts by which it is rising are growing, the momentum indicator trends upwards. If a market is rising but by declining increments, the momentum indicator will trend downwards. The inverse is the case in declining markets.

When the momentum index in a rising market is falling, a fall in the market is said to be imminent. Such a pattern is known as "bearish divergence". From March to May the All Ords rose slightly from point A to point B. But the momentum indicator failed to make a higher high, with point D on the momentum chart being above point E. Bearish divergence had emerged and the market fell nearly 11 per cent in four weeks.

Between May and late July the All Ords recovered but did not hit its May highs. So point C on the chart is a "lower high". Meanwhile, the momentum indicator made a much lower high at point F. With the All Ords climbing a little higher from point C we can say that bearish divergence is back.

Inter-market analysis of the German DAX index and its momentum indicator show both moved higher in a choppy period between March and May then fell away, as did the Australian market. The DAX then returned to its highs in July and August, but its momentum indicator fell sharply to July and is still at low levels, indicating there may be upcoming weakness in the DAX. Recent downward trends have been seen in some other important markets as well.

All that international weakness lends weight to the negative implications of the bearish divergence in the All Ords. Such bearish divergence was present before the downturns in 2008, 2011 and 2012.

This column is not investment advice. rodmyr@gmail.com

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