Principles of Momentum Interpretation 9

line or sometimes even before the oscillator reaches that point. This trait itself
is a primary characteristic of a bull market.
You may also notice that the initial thrust off the final market low
accompanies what I call a “mega-overbought condition.” A mega overbought
condition is a sign of a very young and vibrant bull market. The fact that an
oscillator is able to generate such a condition can be used with additional
evidence of a trend reversal to indicate that the bulls are running once more. In
effect, such action signals that the state of equilibrium between buyers and
sellers has unequivocally shifted in favor of buyers. This is about the only
instance when an investor can justify opening a long position if a particular
market is saturated with buyers. Even so. the only rationale for opening long in
this case is that the investor has a long-term time horizon. Whenever an
oscillator experiences a mega-overbought condition, higher prices almost
always follow at some point down the road.
In the case of oversold extremes, the same condition also applies in
reverse. In other words, a characteristic of a bear market is an oscillator that
tends to (1) move beyond the accepted norm, (2) remain in an oversold state for
an extended period, or (3) do both. Another sign of a bear market occurs when
a price decline following a new bull-market high pushes a momentum indicator
to an extreme low that is well beyond anything seen in the previous six months
or so. This implies that sellers now have the upper hand. The fact that it is
possible for the momentum indicator to plunge so sharply and so deeply is by
itself a sign that the character of the market has changed. This is illustrated in
figure 1.4. An actual marketplace example is shown in chart 3.2.

Divergences

When price and momentum are moving in the same direction, they are said to
be “in gear." There is nothing important to be learned from this state of affairs
except that the trend is healthy. However, when momentum does not confirm
the price, beware: The prevailing trend may be about to reverse. In the
description ot overbought and oversold conditions we assumed that the
oscillator peaks and troughs at roughly the same time as the price. This is not
often the case, however. An equally likely possibility is that the momentum
indicator will turn ahead of the price. Think of a pen thrown into the