With the assistance of Dorsey, Wright & Associates we use, measures of momentum and overbought/oversold readings to aid in our interpretation of a stock or an index. The measures are computed by their database, and can be accessed by clients.
Momentum: Following weekly momentum is very helpful when timing trades. A positive weekly momentum suggests higher prices and negative momentum suggests lower prices. Weekly momentum is a shorter term timing tool as changes to positive or negative weekly momentum last seven weeks on average. We can calculate the number at which momentum will change to positive or negative. If the price of a stock is below the price that stock needs to hit in order to change its momentum, then the change number is where the momentum will turn positive. If the price of the stock is above the change number then this is where the weekly momentum will turn negative. See next page for a sample momentum table.
Trading Bands: This is the basic bell curve, giving a picture of whether a stock is overbought or oversold based on a 10 week moving average. 100% overbought is three standard deviations above normal. 100% oversold is three standard deviations below normal. If the stock is 100% overbought, it suggests the stock will correct to normal on the curve. If the stock is 100% oversold, it suggests the stock will bounce to normal. The disadvantage to trading bands is the tails can go out to infinity.