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Updated 6/17/2009

The NASDAQ Rate of Change (ROC) chart is very helpful in getting the "big picture" view quickly. The old saying "a picture is worth a thousand words" is very applicable to this chart.

Once you understand what it is showing you this chart will easily point out the direction of the market and make it easy for you to decide whether you want to be in or out of the market.

The NASDAQ Rate of Change (ROC) chart shows the annual rate of return along the left axis and the years since 1990 along the bottom.

Remember this chart shows the rate of return not the current price so it is much easier to see performance. Want to know if we are up or down from last year? Simple, if we are below the zero line... the NASDAQ is down, if we are above the zero line... the NASDAQ is up.

The key is to exit positions while we are in positive territory (with a gain above the line) rather than waiting until we have a loss. We simply exit,  sit on the sidelines safely with our money intact and 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 if the slope is up the market is moving up. And obviously if the line is basically flat the market is not trending at all. 

Just because this chart is not moving higher does not mean we should sell.  In the period from June 2004 - June 2007 the red moving average line was basically flat, although it had a bit of wiggle, but it was still flat at around 10% rate of return so holding during that period would have produced returns very close to the long term average. 

If you are 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 been holding the entire NASDAQ for the previous 12 months. This can be achieved through the use of an index fund or ETF.

Current Analysis:

The index has crossed above it's moving average for the first time since October 2007. This is a big event but the question remains is it a buy signal?

The answer can be seen inside the blue circle around 2002.  There we can see a very similar situation.  The market had crashed during 2000 -2001 and finally around November 2001 the index crossed back above its moving average with the index around 1579 in September 2001 .

But was it a good time to buy?  Well that depends. In October and November 2001 the NASDAQ rose 7.39% and 12.04% respectively. December rose 2.77% so people started seeing "green shoots" although they didn't call them that back then.  So then on a monthly basis January and February 02 the NASDAQ lost -3.08%  and -7.52%  giving back pretty most of the gains of October, November and December.  March was up 6.72% April was down -6.13%. Then May, June, and July lost -1.61%, -9.98% and a whopping -18.75% respectively.

It was actually a massive "suckers rally"  but short term traders made a lot of money.  February 2003 the NASDAQ stood at 1310.   

Notice that although at points the index is rising rapidly the annual rate of return never crosses above the zero line.  This means that if you held short term you could make money but holding long term was still a losing proposition.

We can see that the final crossing above the moving average didn't happen until April 2003.

And it wasn't until June that the index finally moved above the zero line.  and where was the NASDAQ at that point?  At 1628 it was very close to its level back in 2001.  If you had stayed out that entire period you could have earned nice safe interest for almost 2 years and not risked a single penny in the stock market.

The current rally is beginning to look much like the suckers rally of 2001. Like  in late 2001 we have seen a few months of  significant gains.  Then it was 7.39%, 12.044% and 2.77%.  Now it is 1.34%, 13.02%, 0.70% and finally 7.93% over the last month.

As we can see from the chart the annual rate of return is still quite negative at
 -26.82%.  So we are about due for some negative returns like back in 2002.

I have been saying, "The NASDAQ was extremely oversold offering the opportunity to bounce back a bit but that by no means indicates that the pain is gone for good.  There is still a very good possibility that this is just a bear market rally".

And as of this writing it looks like a drop is imminent.

Last month I thought, " it looks like we may actually be at the crest of a Bear market rally and I wouldn't be surprised if next month the NASDAQ is significantly lower than it is today".  But it didn't materialize... perhaps I was a month early.

At this point the ROC is technically above its moving average but still below the zero line making it a traders market and not safe waters for long term investors.

If you are worried about missing the rally think about this,  the last safe buy signal occurred in June of 2003 with the NASDAQ at 1627.  We are currently in nowhere near as safe a position and 6 years later... last month the  NASDAQ was at 1664.  A very good reason to listen to the ROC.  Long term investors need to keep your powder dry and wait for a safe entry point (and this isn't it.)

My feeling is we will see 1600 again (maybe several times) and we will probably see 1300 again as well.  In between we may see both 1900 and 1400.

See the NYSE ROC for further details.

Tim McMahon, Editor
Financial Trend Forecaster

Disclaimer:

At Financial Trend Forecaster we are not registered investment advisors and do not provide any individualized advice. Past performance is not necessarily indicative of future performance and future accuracy and profitable results cannot be guaranteed.