V.9:5 (202-205): Double-Smoothed Momenta by William Blau

V.9:5 (202-205): Double-Smoothed Momenta by William Blau
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Double-Smoothed Momenta by William Blau

The prices of stocks and commodities are usually plotted as bar graphs. In a bar graph, each bar represents a certain time interval, be it an intraday, daily or weekly bar. The last price in each time interval is designated as the close. For certain markets, the daily close is actually a price determined from the period that makes up the closing range.

The close, or settlement price (the price at which all outstanding positions in a stock or commodity are marked to market), could be considered the most important piece of trading data. One reason is that the close may psychologically affect the trader's outlook. For example, a position that is a loss during an intraday time period may become profitable by the close, increasing the trader's confidence that the position is the correct one. Another reason is that intraday volatility often clouds the true direction of the market. Focusing on the closing prices can provide a clearer picture of the trend. Numerous technical indicators are based only on the closing price.

However, many technical indicators that a use the closing price are oversensitive to the singular changes in direction of the closing price. A number of these indicators will in effect give false trading signals due to this sensitivity. Clearly, the method used to smooth the price curve is very important. An indicator that gives smooth curves that indicate price levels at important peaks or valleys would be a superior trading tool.

One such indicator is the Double-smoothed Momenta (DM). The formula for the double-smoothed momenta relates various portions of a series of closing data to today's close (Figure 1). The formula takes into account maximum and minimum values of the closing price in prescribed intervals. These relationships are then smoothed through the use of multiple exponentially smoothed moving averages (or, in other words, an exponential moving average of an exponential moving average). This indicator is designed to warn of overbought and oversold market conditions and to reduce false trading signals.

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