Visualizing Business and Market Cycles Through Market Momentum
Investopedia is partnering with CMT Association on this newsletter. The contents of this newsletter are for informational and educational purposes only, however, and do not constitute investing advice. The guest authors, which may sell research to investors, and may trade or hold positions in securities mentioned herein do not represent the views of CMT Association or Investopedia. Please consult a financial advisor for investment recommendations and services.
Visualizing Business and Market Cycles Through Market Momentum
Last year I produced several posts that described a methodology utilizing long term momentum changes between asset classes and the relationship among asset classes to help anticipate the business cycle. That series is linked below.
When I worked in the institutional setting I would place hundreds of assets, ratios, spreads of individual corporate bonds and equities into a 4 quadrant MACD momentum matrix. I would then condense the raw data into thematic groups and see what the matrix implied about the business cycle. As an individual investor with limited time and fewer resources, I generally plot 80 assets and spreads and find that sufficient to extract a view.
For most of the last two decades the liquidity regime provided by monetary and fiscal policy disrupted the economies natural cycle. But, I believe that policy inflections have occurred and that asset prices will again become more connected to the real economy and less connected to policy. Analysis such as this will again become more useful.
Methodology: Individual markets and ratios are plotted in the quadrant that best describes their combination of momentum and price action. The precise point where the individual plots fall in the matrix is not nearly as important as the overall pattern of multiple plot points and the general weight of the evidence. It is important to realize that the momentum state is not always obvious. Accept that its messy and use your best judgement in deciding on quadrants. The idea is to build a general view of the market and economic cycle.
What defines the momentum quadrant? The monthly perspective moving average convergence divergence oscillator (MACD). The individual quadrants reflect the relationship between the 13 and 26 month exponentially smoothed averages.
Quadrant One: Waning Bear: In this quadrant momentum is bearish with the shorter average below the longer average, but the difference between the two is becoming less. Momentum is still lower, but at a decreasing rate.
Quadrant Two: Strong Advance: In this quadrant momentum is bullish with the shorter average above the longer average and the difference between the two is becoming greater. Momentum is higher at an increasing rate.
Quadrant Three: Waning Bull: In this quadrant momentum is bullish with the shorter average above the longer average, but the difference between the two is becoming less. Momentum is still higher, but at a decreasing rate.
Quadrant Four: Strong Decline: In this quadrant momentum is bearish with the shorter average below the longer average and the difference between the two is becoming greater. Momentum is lower at an increasing rate.
Trading Range: A market in a trading range is removed from the matrix until it breaks from the range even if MACD momentum has been falling/rising for months.
Over the next few posts, we will briefly address the construction of the matrix, and attempt to draw conclusions around the market and economic cycles. If you are interested in the methodology, please visit the links below for in depth discussion.
And finally, many of the topics and techniques discussed in this post are part of the CMT Associations Chartered Market Technician’s curriculum.
—
Originally posted 7th November 2023
Disclosure: Investopedia
Investopedia.com: The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. While we believe the information provided herein is reliable, we do not warrant its accuracy or completeness. The views and strategies described on our content may not be suitable for all investors. Because market and economic conditions are subject to rapid change, all comments, opinions and analyses contained within our content are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy. This information is intended for US residents only.
Disclosure: Interactive Brokers
Information posted on IBKR Campus that is provided by third-parties does NOT constitute a recommendation that you should contract for the services of that third party. Third-party participants who contribute to IBKR Campus are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from Investopedia and is being posted with its permission. The views expressed in this material are solely those of the author and/or Investopedia and Interactive Brokers is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to buy or sell any security. It should not be construed as research or investment advice or a recommendation to buy, sell or hold any security or commodity. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Join The Conversation
If you have a general question, it may already be covered in our FAQs. If you have an account-specific question or concern, please reach out to Client Services.