[part 1] MOMENTUM HIDE AND GO SEEK
So far we’ve confined our discussion of momentum to the challenge of recognizing the true slope of closing prices accurately. We must focus on a different aspect of price to find the most overlooked hidden momentum.
Here’s the answer. Momentum hides in the movement of implied volatility. A good recent view of implied volatility is where we should measure momentum on the stock chart. The simplest direct gauge of this is to use a true slope indication of the N Band [[ proprietary ]] . Because implied volatility in its primary form exists as a dynamic matrix of percentages produced by option valuation models, it is difficult to identify as a single value. The N Band well represents a consolidation of its most critical levels. It does so in the immediate time frame as direct support and resistance, and in the future as Projected Implied Volatility (PIV), quantified by S/R lines. Significantly high levels of N Band slope [[ proprietary ]] , therefore contain hidden price momentum. Another way to express this is that significantly high levels of N Band slope contain the energy for potential price movement.
Figure 11.1,shows the lower N Band slope measurement. The following are the volatility dynamics at work, which result in hidden momentum. As the lower N Band rises, the more immediate downside volatility for a stock decreases in that time frame. Thus, the perceived probability of the stock’s price to fall decreases, and the perceived probability for the stock’s price to rise increases.
As the lower N Band falls, the more immediate downside volatility for a stock increases in that time frame. Thus, the perceived probability of the stock’s price to fall increases, and the perceived probability for the stock’s price to rise decreases.
As the lower N Band rises, the future potential for downside PIV for a stock decreases in that time frame. Thus, the perceived probability of the stock’s price to decline is also decreased.
As the lower N band falls, the future potential for downside PIV for a stock increases in that time frame. Thus, the perceived probability of the stock’s price to decline is increased.
The same tendencies occur in an inverse manner for the upper N Band.
This theoretical stored price momentum has its roots in logic. It can be best described somewhat anecdotally. Consider that a stock’s closing price is sitting evenly between the upper and lower N Bands. The upper N Band stays at the same value over the next few periods. The lower N Band rises in each of those same periods. Price declines over the same few periods. This means that price and the lower N Band are moving toward each other. Since the lower N Band represents immediate support and is rising to meet price, then a long trade entry begins to show a higher success probability because support (lower N Band) is nearer and resistance (upper N Band) is further away.
The analyst’s interpretation of this situation is that upside volatility is now greater than downside volatility; and indeed, it is. With all other things being equal, as long as the downside implied volatility is being reduced at a greater rate than the upside volatility, then these conditions favor greater short-term trade success on the long side versus the short side.
Focusing too intensely on simple price movement can lull the analyst’s judgment.
Remember that “volatility cycles even when price does not.” If you are really having trouble sleeping and want to dive deeply into the reasons why this is so, then research the mathematical models of ARCH (autoregressive conditional heteroskedasticity) and GARCH (generalized autoregressive conditional heteroskedasticity).
So how can we be more secure in believing that a rapidly rising N Band improves the probabilites for a rising price? Certainly a handful of examples can be found that support virtually any theory, good or bad. How can we feel confident that these slope measurements will identify additional hidden momentum?
[[ An anlaysis is then undertaken to test the effectiveness of this approach – the following are his main findings (edited):
* When the lower N Band has a high slope condition, the potential trade
profit increases from 5.3 percent to 9.0 percent. That’s a 69.5 percent increase. The largest implication of this study is that the potential profit increases two and a half times more than the potential loss: 69.5 percent versus 28. 7 percent. That means that the increase in profit is not just due to volatility magnification. It strongly supports that there is genuine value to the high slope measurement.
The bottom line here points to a win-win proposition of volatility analysis. The change in performance between the two groups is due to high N Band slope because the disproportionate increase in profit to loss improves the successful trade probability. ]]
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