DECAY (Price Decay Indicator)
The Price Decay Indicator is a technical analysis tool that measures the rate at which price momentum deteriorates over time. It helps traders identify potential trend exhaustion points and price reversals by analyzing how quickly price movements lose strength. The indicator is particularly useful for determining when strong trends might be running out of steam and ready for a reversal.
Formula
DECAY = (Current Price - Previous Price) × Decay Factor^n
Where:
Decay Factor = Rate of momentum loss (typically 0.5 to 0.9)
n = Number of periods since price change
Previous Price = Price n periods ago
How DECAY Works
The DECAY indicator calculates how quickly price momentum is deteriorating by applying a decay factor to price changes over time. A faster decay rate indicates rapid momentum loss, while a slower decay suggests sustained momentum. The indicator helps traders identify potential reversal points when price momentum begins to fade, even if the price is still moving in the trend direction.
Trading Strategies Using DECAY
Strategy Examples
- Enter counter-trend positions when decay rate accelerates
- Exit trending positions when decay shows momentum loss
- Use decay readings to time trend reversal entries
- Combine with momentum indicators for confirmation
- Scale out of positions based on decay strength
Support and Resistance Strategy
- Monitor decay rates at key support/resistance levels
- Look for decay acceleration near price barriers
- Use decay to confirm breakout sustainability
- Identify potential reversal zones using decay patterns
- Combine with volume analysis at key levels
Trend Identification
- Low decay rates indicate strong, sustainable trends
- High decay rates warn of potential trend exhaustion
- Monitor decay pattern changes for trend transitions
- Use decay acceleration to spot trend weakening
- Compare decay rates across timeframes for trend strength
Advantages and Limitations
Advantages
- Effective at identifying trend exhaustion
- Helps time reversal entries more precisely
- Provides early warning of momentum loss
- Works well in trending markets
- Useful for position sizing decisions
Limitations
- Can give premature signals in strong trends
- Decay factor selection affects accuracy
- May be less reliable in choppy markets
- Requires confirmation from other indicators
- Can be sensitive to timeframe selection
Best Practices When Using Decay
- Combine decay analysis with other technical indicators for confirmation
- Use multiple timeframes to validate decay patterns
- Wait for clear decay acceleration/deceleration signals before acting
- Consider overall market context when interpreting decay signals
- Monitor decay rates alongside volume for stronger confirmation
- Look for divergences between price action and decay patterns
- Adjust decay factor settings based on market volatility
- Be cautious of false signals during ranging or choppy markets
- Set appropriate stop-loss levels based on decay readings
- Regularly review and optimize decay parameters for current conditions