What is the NYSE Rate of Change (ROC)©?
The NYSE Rate of Change (ROC) chart is helpful in getting the “big picture” of the stock market very quickly. The old saying “a picture is worth a thousand words” is very applicable to this chart. Once you understand how to read the ROC chart you can easily spot the direction of the market which makes it easy for you to know whether you want to be invested in the market or not. (See Below for Current NYSE Analysis)
The NYSE Rate of Change (ROC) chart shows the annual rate of return along the left axis and the years since 1990 along the bottom.
Since this chart shows the rate of return rather than the current price it is much easier to see performance, we don’t have to guess if we are up or down from last year. If we are below the zero line… we are down, if we are above the zero line… we are up. The key is to exit positions while we are in positive territory (with a gain) so we can avoid the loss and then we can reenter when we get a buy signal.
The red line is the 12 month moving average. As with most moving averages a buy signal is generated as the index crosses above the moving average and a sell signal is generated as the index crosses below the moving average. (See Current Analysis Below)
Another helpful way to use this chart is to look at the slope of the red moving average line. If the slope is down the market is trending down (gains are getting smaller) if the slope is up the market is moving up (gains are getting bigger). And obviously if the line is basically flat the market is not trending at all. But a flat line at say the 10% level is not bad it means the market is gaining a steady 10% a year which would be very good.
Just because this chart is not moving higher does not mean we should sell. In the period from May 2005 – May 2007 the red moving average line was basically flat, although it had a bit of wiggle, but it was still flat at around 12% rate of return so holding during that period would have produced returns above the long term average.
If you are a short-term trader or simply looking for big gains, the best buy signals come from a movement from below the 0% line. This allows you to capture the greatest up move.
Note: While viewing this chart we must remember that it represents the rate of return we would have earned if we had invested in the entire NYSE for the previous 12 months. Which can be achieved through the use of an index fund.
Is there a correlation between inflation and the stock market ? This chart compares decade inflation and stock market returns during the decade.
Current NYSE-ROC Analysis:
Last month I said, “Typically December is a good month for stocks because all the funds are buying and selling in an effort to dress up their holdings to make them appear better than they actually were. But this month the NYSE has fallen significantly for the first half of the month but it looks like the “window dressing” season has begun as the market has rebounded a bit. However, the NYSE is still down -1.74% over last month but is up 7.1% over year ago levels. But we still have a sell signal in spite of the rebound.”
And so now that the window dressing season is over the market is falling again. At current levels the NYSE is just 1.25% above year ago levels. This is why we were out of the market last February, we could relax and invest in interest bearing fixed dollar investments and not risk any loss.
The Current NYSE Chart
As we can see from the chart the NYSE has made a series of lower highs in an attempt to break through the 11,106 barrier. It also made two higher lows. But today’s low is virtually identical to the previous low so if it continues lower tomorrow we will have a lower low which will be very bearish.
Last month I said, “Honestly, I was expecting another lower low (i.e. below 9,886.08) which would have indicated a top was in place and we could expect a severe correction. But at this point it appears that we will get a fourth test of the resistance line. Since peaks appear approximately two months apart we should see the test somewhere in January. If it can somehow break through the resistance line that would be bullish …” But that hasn’t happened so things are not looking good for Mr. Market.
Also current levels are below the green 200 day moving average by more than 250 points so that is another confirmation of a down trend in place.
Length of Stock Market Rallies
Our friends at Chart of the Day published the following chart on September 3, 2014.
When you first look at it you might think, “Oh well this rally is only about half way to the max based on both magnitude and duration. It is less than average… so it has a long way to go.” But does it?
The chart plots “major rallies” since 1932 i.e. an average of one every 3.7 years. In this case, a major rally is defined as an advance of 30% or more that follows a 15% or greater decline. There have been 23 major rallies using this definition during this period. The current rally began with the 2011 correction of 19.4% and started counting at the October 2011 low. From there the market has increased 91%. By looking at the chart we can see that the current rally is still a bit anemic in that it is below the linear regression average line but has already lasted a bit longer than average so a correction is overdue. As a matter of fact out of the 23 only 6 have lasted longer than the current rally and 1953 lasted virtually the same length but produced much better returns. So we have 6 lasting longer without a correction and 16 lasting shorter. One factor that might influence our perception is that two of the longest 1990 and 2002 are more recent. So it is possible that the FED’s actions are extending the duration of the rallies but they could also be making the crashes worse as well.
Note: The S&P 500 was not adjusted for inflation or dividends. Selected rallies were labeled with the year in which they began. There are 252 trading days in a year (100 trading days equal about 4.8 calendar months).
Back in May Chart of the Day published the following chart with slightly different parameters. In this one, the rallies followed a decline of 30% or more (rather than only 15% in the more recent chart). So in this chart the rally began after the 2008 crash and the 2011 drop was just a “correction”. Looking at it this way there are fewer points of reference (only 13) and since this chart was created we have moved a bit closer to the average point on this chart.
In August 2012 the NYSE ROC generated a definite buy signal, not quite as dramatic as the one in 2009 but a good buy signal none-the-less. And the rate of return shot up considerably. Then the rate of return bounced around above 10% coming close to the moving average but not crossing below. In the Summer of 2013, FED chairman Bernanke spooked the markets with his talk of backing off the accelerator but then he decided to take it back, so the markets picked up again. Up until September 2013, the red moving average line was trending up and the index remained above the moving average.
But in September, possibly out of concern over what would happen when Bernanke retired, the black line crossed below the moving average generating a sell signal. At that point, we asked, “Is this “the sell signal” that signals the end of the bull market? Or will it just be another whipsaw?” We said, “Only time will tell, we are at the end of the summer and the market may be picking back up again for the winter months.” In October, it seemed that the market had accepted that the new FED chairman Yellen will continue on the easy money path so the market picked up again moving the NYSE once again in buy territory. Then for the next month, the market went basically nowhere so the annual rate of return dropped from 25.8% to 20.23%. But a 20% annual return is still excellent. Unfortunately, 20% is generally unsustainable and high returns like that generally indicate overbought conditions and the making of a bubble.”
In February, the rate of return line crossed below its moving average generating a sell signal at around 10,250. And I said, “Of course this could be the tail end of the January slump and we could get another whipsaw upward (which is highly likely) but we have received an early warning alert and we need to be cautious at this point.” Since then the Ukraine and Iraq have caused some concern in the market and we remain in sell territory. Four months later the market had suffered some bad down days but still actually made new highs.
On our ROC chart back in November it was traveling at a “speed” of over 25% per year. It dropped to 20%, then 19%, 16%, 14.5%, 14% and in May it was at 11.5%. June kicked the annual rate of return back up to 16.58% but by July the annual rate of return had dropped off a bit to 15.48%. All of these are good rates of return but are they worth risking a 30% drop in the value of your holdings?
The red moving average had turned down. The Volatility Index (VIX) was historically low indicating complacency in the market. No one was worried… the FED will save the day. The problem is that as market participants become more and more complacent the risk of a “Black Swan” event happening becomes greater and greater. So the possibility of a market crash is actually increasing due to the FED’s actions. Then the FED began tapering and no one was worried and now the market is testing a 10 correction but it could easily continue to a 15% to 20% correction.
Also see the Inflation Adjusted NYSE Stock Index – how has the NYSE fared when inflation is taken into consideration?
For more information see: NASDAQ Rate of Change
Tim McMahon, Editor
Financial Trend Forecaster
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