Members occasionally ask for more information on how the the Absolute Acceleration value used in the Kipling SS’s is calculated. This post should answer this question.
The intent of the absolute acceleration (AA) calculation is to provide an indication of whether momentum is increasing (accelerating) or decreasing (decelerating – negative acceleration) at the time it (momentum) is measured.
Momentum is measured as
Mom = (P(t) – P(t-n))/P(t-n)
Where P(t) = Price at time t, and
P(t-n) = Price at time t-n
…. and when we are simply ranking momentum over a fixed lookback period we do not have to worry about the length of the look-back period. However, if we wish to compare momentum over different lookback periods we strictly need to calculate the Rate Of Change (ROC) of Price or
ROC = Mom/lb(t)
Where lb(t) = look-back period (days)
Absolute Acceleration (AA) is then calculated as
AA = ROC1 – ROC2
Strictly speaking this difference should be divided by ROC2 but, since we are only using the value for comparative purposes, we can ignore the denominator since it will be common for all assets in the portfolio.
Then, since the difference between the 2 (true) ROC values is a small number, this is multiplied by 252 to annualize it and give us a number that can be more easily digested.
The intent was to provide a relative number that could be used to determine:
- Whether momentum was increasing or decreasing in the shorter term period;
- A ranking of the strength of the recent momentum vs the longer term momentum.
Graphically we have a number of possible scenarios:
……… and we have to be a little careful. The above figures show possible configurations of long term momentum (blue) and short term momentum (red) with the corresponding values (positive or negative) of calculated AA. Thus,
- although AA might be negative, this might be a slowdown (Fig 2) or pullback (fig 4) and a reflection of a reversion to a mean that might provide support before a continuation of a longer term uptrend – or it could be a sign of a reversal;
- A positive AA might be an advance indication of a reversal (bottom fishing) even if longer term momentum is negative and rankings are not high (Fig 3)
- a very strong AA in a longer term uptrend (fig 1) might reflect an exponential price move that could well result in the asset being overvalued (high RSI)
The REDA classifications are designed to identify situations that might result in a continuation of the trend/upward momentum when the REDA classification is Hi and are based on an analysis of ~40,000 21-day trade setups.
I hope this helps in understanding the AA concept.