No indicator, no matter how much faith you have in it, is the ‘holy grail” of market timing tools. Nothing will give you the definitive, absolute answer as to which direction the market might end up going in the near, or even intermediate term.
Having gotten that out of the way, we can look at indicators that have been reasonably good indicators of pending change. One such indicator that seems to be pretty good at signalling longer termed shifts on the monthly charts is the Rate of Change indicator. This indicator –a.k.a. the ROC indicator, is the granddaddy of today’s sophisticated momentum indicators. It’s about as pure as you can get when it comes to price momentum. No BS baffling brains or smoke and mirrors here. I like it for longer termed charts, and look for divergences in ROC vs the price of the market in question. For more information on using this indicator vs using other oscillators, read Martin Pring’s book on momentum, or my book Sideways.
The ROC indicator has a simple formula. Here it is:
ROC = [(Close – Close n periods ago) / (Close n periods ago)] * 100
Even the least mathematical of us can see that this formula is basically looking at the price movement, as a percentage, over a given period of time. If you use stockcharts.com, they use a default of 12 periods. On my monthly 16 year chart below, I changed that lookback period to 6. So it’s looking back every 6 months and comparing the percent of change on the upside. Pretty simple stuff. But its beauty as an indicator is that it is so simple! If the market makes a new high on a lower high for the ROC, you have a sign that things are slowing down internally. Price change is slowing. The market is losing momentum.
I probably don’t have to walk you through today’s chart. You will see that this indicator isn’t wonderful for precisely pinpointing the turning point. Nor is it a sure thing if it diverges—but it’s pretty darned reliable most of the time. Its prone to giving us long look-ahead warnings. You have to take that into consideration when viewing these divergences. Just because its diverging and has been doing so for a year, that doesn’t mean that today it’s time to sell. But it may mean that you should keep your eyes wide open for a breakdown in the charts. Ample warnings were provided by ROC for the tech crash and the 2008 oil/debt crash. Not to mention 1994, 2011, 2012 and early 2016. Simply note the higher high on the S&P and see if ROC confirms it with its own higher high. Simple, right?
Right now, monthly ROC is flat against a higher S&P 500 price level. Should ROC deteriorate – it may be a warning sign. The fact that it hasn’t made a new high is suggesting that momentum is slowing for the US markets. This suggests caution, but not panic. Should that condition of slowing momentum remain in place, it may be a bearish signal. We shall see.
Keith was on BNN on Monday June 12th for their 1:00pm show. Click here to see the full clip.