USING THE PRICE MOMENTUM OSCILLATOR (PMO) FOR RELATIVE STRENGTH RANKING AND ANALYSIS

The exact calculation method for Decision Point's Price Momentum Oscillator (PMO) proprietary, but for your general understanding we can say that it is an exponentially smoothed Rate of Change (ROC) calculation. Since this is an internal ratio calculation (versus external, which uses another price index for calculating the ratio), it returns a result that can be compared to a PMO result for any other security or index.

In other words, we can rank a list of securities or indexes in relative strength order simply by using their PMO values, the highest PMO value is first on the list an so on. The list does not have to be homogeneous -- all PMOs are related, so we can rank market indexes, stocks and mutual funds in the same list if it suits our purpose.

Most relative strength lists are one dimensional. We can see how the members of the list are ranked in relation to one another, but it is like a snapshot of balls that have been thrown into the air -- we cannot tell in which direction they are moving, nor can we discern their movement in relation to one another.

Decision Point relative strength lists are three dimensional. For an example let's look at the relative strength list of prominent market and sector indexes extracted from the Decision Point Alert daily report for May 2, 2003. Note that: (1) Items are presented in relative strength rank order; (2) each item's 5-day and 15-day rank change numbers show us how many places the item has moved up or down in the rankings within a given time frame, so we know if the item is gaining or losing relative strength; and finally (3) the 5-day and 15-day percentage price change columns tell us if up/down movement within the ranks is being caused by price movement in the appropriate direction.

The Hot/Cold Group designation classifies securities/indexes into six (6) groups ranging from 1 (Hot) to 6 (Cold) according to the strength/weakness of price movement and internal strength (PMO). We can quickly assess the condition of these elements by the group number and "blinker" fields. The blinkers are a series of five plus (+) or minus (-) symbols we can use as a quick reference for what is going on with the indicators we are monitoring. Moving from left to right: The first blinker tells us if the PMO is above (+) or below (-) its 10-EMA (10-period exponential moving average). The second blinker indicates if the closing price is above (+) or below (-) its 20-EMA. The third and fourth blinkers tell us if the PMO is rising (+) or falling (-), and if it is above (+) or below (-) zero. The fifth blinker tells us if the 5-day relative strength rank change is positive (+), negative (-), or no change ( ) For more information see our article on Hot/Cold Groups and Blinkers in the Glossary.

Our relative strength lists help us get a sense of the dynamics of the rotation within the group. Above we can spot indexes that seem to be losing upside momentum, like the Semiconductor Index , as well as those that seem to be picking up steam, like the Telecom Index. As a general rule, relative strength rotation tends to be faster in bear markets, so you would look for short sale candidates at the top of the list. In bull markets leadership tends to persist for long periods, so you would look for momentum plays from among the indexes at the top of the list.

In bull or bear markets you would look toward the bottom of the list for indexes with emerging strength. Short sales are only recommended during bear market conditions, and you should normally look of short sale candidates near the top of the list. Indexes ranked low on the list have probably already experienced substantial declines and would not make good short sales candidates.

It is our general observation that the PMO addresses a relatively short-term time frame compared to other relative strength ranking systems. This facilitates short-term trading decisions as well as early entry for longer-term investment positions. The extraordinary advantage of our PMO ranking system is that this one indicatorcan be used to make both relative strength assessments and trading decisions. The dynamics of the relative strength rotation is being driven by the oscillation of the PMO within its normal trading range, and, when we look at the chart of an individual security or index, the PMO gives us an instant assessment of its personality and potential within the context of the broader relative strength picture, as well as what trading decisions might be appropriate.

RELATIVE STRENGTH RANKED CHART BOOKS

Tables, like the one above are useful for making a quick scan of a large group of securities or indexes, but charts ultimately tell the full story, so Decision Point has chart books (6-month and 2-year time frames) to facilitate a more penetrating analysis of a particular group. For example, we have a chart book containing charts of most of the items on the above list, but let's dig even deeper.

Note that the Semiconductor Index (SOX) is ranked number 4 above, but the 5-day rank change of minus one indicates it might be losing upside momentum, so let's look at our chart book containing the stocks in the SOX  Index. Note that the charts appear in relative strength order, and there is even a chart of the SOX index, ranked appropriately, so we can see which stocks in the index are stronger or weaker than the index itself.

As we scan through these charts, we can observe the kind of chart patterns that are developing, but, most important, we can observe and evaluate the PMO. Remember, the PMO is the device by which we establish the relative strength rank, but it also functions as a traditional momentum indicator; therefore, as we scan through the chart book, we can also use the PMO to evaluate the technical condition of the stocks in the SOX.

In this case, even though nearly all the PMOs are rising, their trends are mostly weak to sideways. This is in sharp contrast to the healthy looking PMO up trends we can see on the left side of the same charts (November time frame). PMOs are relatively ovebought, and there are a number of negative divergences. Overall, we would conclude as of 5/3/2003 that there are probably better places to put money than in the SOX Index.

Note: Although we can't demonstrate it with this particular graphic, we should mention that our normal chart book functionality in PRIME provides the capability to drill down even farther. If you want to take a closer look at a particular stock in the chart book, simply click on its chart, and our ChartTool will pop up with a chart of that stock, and you can perform your own technical studies on it using various indicators and in different time frames.

Conclusion: Relative strength and momentum are important elements of technical analysis. Decision Point's use of  a single indicator, the Price Momentum Oscillator (PMO), to perform combined analysis of both these elements, provides us with unusually powerful tools and insights.

Next we will outline a trading system using the PMO.

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