Technical analysts are warning that a divergence is building between the S&P 500’s price action and underlying momentum. However, there has not been a catalyst for sellers to fully take control just yet, writes Tom Bruni, head of market research at The Daily Rip by Stocktwits.
Momentum is a key component of trend following and is often looked at to confirm (or question) the strength of an underlying price trend in an asset. We all know that momentum shifts before direction. When you toss a tennis ball up in the air, its momentum (rate of change) slows as gravity pushes down on it, and eventually, it comes to a halt before reversing and falling back down.
The same goes for a stock or any other asset. Every new high in price requires an incremental buyer and every new low requires an incremental seller. But eventually those parties get tired for some reason or another and the other one takes over.
One indicator often used to measure this tug-of-war in momentum is the relative strength index (RSI), which is plotted in the secondary pane below. It’s marked on a scale between 0 and 100, with the 70 region marking overbought territory (strong buying momentum) and 30 marking oversold territory (strong selling momentum).
In a perfect world, this indicator moves along with price, so when prices make new highs, RSI makes new highs. When prices make new lows, the RSI makes new lows, too.
When they don’t move together, however, analysts start to pay attention. Just like the tennis ball losing momentum as it climbs upward against gravity, waning momentum in a stock is a sign of a potential trend change. And now is one of those times.
So, how do technical analysts identify a real trend change vs. a warning sign like we’ve had over the last few months? By combining the indicator with other technical signals like a trend break.
And that’s what many traders are watching for now. Prices have been riding this steady uptrend line for months, but a break of it would signal a potential trend change. Analysts say that combined with the momentum divergence that’s been building, would be a clear sign that bears have taken control of the short-term trend.
