Could you please advise how you work out the trend mean and also at which percentage and up that you regard it as overextended. I note that you use a 40 ema on the weekly.
Thank you for this question which comes up from time to time. We use the 200-day exponential moving average which is analogous to the 40-week MA. Incidentally, the Chart Library only does the calculation once so that regardless of whether you are looking at a daily, weekly or monthly chart the moving average will be calculated using days.
Deciding by how much an instrument needs to be trading above its trend mean to qualify as an overextension will depend both on what is characteristic of that market and the stage of the cycle the instrument is in. For example, a volatile share like Amazon routinely has overextensions in excess of 10% while for an Index like the Dow Jones Industrials Average that condition is relatively rare.
Meanwhile it is normal for prices to become overextended following a breakout from a well-defined range because the trend has been inert and the breakout is therefore surprising. That generally signifies the beginning of a trend while an acceleration following an already well-established consistent trend is suggestive of an impending consolidation or even correction.Back to top