One momentum indicator suggests trend change is coming

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?

Year Chart of the S&P 500 with ROC Rate of Change Market Timing indicator suggesting trend change may be coming

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.

 

BNN Monday

Keith was on BNN on Monday June 12th for their 1:00pm show. Click here to see the full clip.

4 Comments

  • http://stockcharts.com/h-sc/ui

    I have used ROC for monthly charts for some time (after reading Pring’s book) but not looking at them often enough. Thanks for shedding more light. My link (if it sends correctly and I know there a lot of indicators there but it is designed that way to provide a complete look on an initial chart) shows ROC at 18, 12 and 6 months. Interestingly, the longest look-back is the highest and the shortest is lowest. Suggestive of a change for sure. The TSX is the same only more so.

    I have been increasingly aware that the TSX is seriously divergent from the U.S. markets. Is this a case of Canadian leadership?

    Reply
    • Fred the CDN market is way too dependant on oil, and the index itself is far less sector-diverse. So its not such a great thing for Canada, and diverging from the USA is immaterial–see my recent posts on the CDN market. Also I am posting on the loonie tomorrow–you might find it interesting.

      Reply
  • Talking about divergence between the TSX and the SPX, something is puzzles me: Compare the insurance sector in the U.S (IAK) to Sunlife and Manulife. While IAK is up 0.45% today, SLF is down 0.15% and MFC down 0.83%. Keith, is this interesting at all to you, or simply a short term anomaly? My best guess is that the index down 1.1% today is responsable for putting pressure on all sectors, including insurance, which otherwise would be up, like it is in the U.S.A.

    It brings me to this idea: Could someone buy insurers based on the price action of that sector in the U.S? In a way, using the U.S sector as a leading indicator for our own insurers?

    Thanks!

    Reply
    • The problem for CDN insurance co’s is the same as CDN banks–they rely on our economy, and that is related to oil.
      So you will see them follow our broad market a bit more than you might think they would, although on the positive, the outlook is for rates to rise in Canada in the 4th quarter and that tends to be positive for insurers and banks. So, lets see what happens.
      The point is, don’t think that US sectors necessarily influence Canadian sectors.

      Reply

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