Updated 6/16/2009

The NYSE 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 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.

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) rather than waiting until we have a 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 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 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 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 NYSE for the previous 12 months. Which can be achieved through the use of an index fund.

Current Analysis:

This month in the NASDAQ ROC Chart I have analyzed parallels between the current market position and that of the aftermath of the 2001 market crash.  This is very important at this point in time so we don't fall into the same traps that are being set all over again. 

Here I would like to show how looking at the angle of the 12 month moving average will give you a very good indicator of the overall condition of the market.

Lets start at the beginning of the chart and work our way through. In mid 1991 the market had bottomed with a greater than 10% loss and returns had turned up and crossed above zero giving us a safe buy signal.  note that the moving average (red line) had been falling but then flattened out.  Unfortunately, at the point of crossing it is just starting to flatten out so it is difficult to know except in hindsight that it was flattening. But what we can see is that the market was way out ahead of the moving average (big space between the black line and the red line).

Next we see the black line getting way ahead of the red line to the upside and then crossing below so we have a sell signal.  Then for a while we are in the whipsaw pattern where the moving average is basically flat and the difference between the two is very slight.  These are not serious sell signals until we see a larger divergence between the moving average and the NYSE ROC.  as we approach the zero line we can feel safe in spending 1994 on the sidelines in January 1994 the NYSE was at 2671 and by December it was at 2509.   So the the divergence below the moving average gave us plenty of warning to put our funds somewhere and just earn interest for a while.

Then in December 1994 the NYSE ROC crossed back above both the zero line and its moving average giving a nice safe buy signal.  And notice the divergence growing between the moving average and the ROC index itself.  Also note the angle of the moving average it is up throughout 1995 so we want to be in the market.  There are a couple of false tops along the way that might wave a yellow flag as the index moves back toward the moving average but when it crosses back below we get a sell signal. We get a good divergence between the index and the average and the average begins trending down.  But note the annual rate of return is still very much above 10%  this is a difficult time to be out of the market so we would probably just begin lightening up on positions selling our winners and taking profits off the table.

Then about mid-1997 we see the moving average is angled down again and the index crosses back above with a nice gap so we are once again safe to be in the market for a while.  Between the July 97 peak and the April 98 peak the market is crazy with large gaps between the moving average and the index.  This is a signal that the top is near. So In mid-1998 when the index crosses below the moving average and it turns is downward again we have another sell signal.  Once again the gap between them grows.  We get a couple of false buy signals as the market tops out in 2000.  Remember the market is not falling at this point it simply is not really going anywhere.  If you take a long term view you see that in December 1999 the market peaked around 6500 and in December 2000 the market was back at 6568.   Anytime in 2000 would have been a good time to exit the market!  The best you could have done was exit in August 2000  at around 6775 and the worst would have been in February at 5926.

But the ROC gave us plenty of warnings that the rewards were diminishing (nearing zero).  So there was plenty of time to exit. 

Throughout 2001 the ROC is warning us to stand clear as returns are increasingly negative so it in no surprise to ROC watchers that in September 2001 we have a "surprise" crash and the market sheds 10% of its value.  In September the NYSE is at 5419. 

The only time the ROC kind of fakes us out is in early 2002 as the index crosses above its moving average with the annual rate of return around -10%.  It looks like a buy signal and and by March it even looks like a confirmation as the index crosses above 0%.  So you might have gotten back in at around 5700 in January of February. By March the market is over 6000 so it is looking good.  But then we get a sell signal  as the annual rate of return begins falling below zero again.  April is -7% and May is -9%  anytime during those two months you could have gotten back out of the market at around 5800.  So the worst that could have happened would have been a 200 point loss or about 3%. 

Looking back... losing 3% while the market sheds 25% doesn't sound too bad.  In March of 2003 we get an early "Trader's Buy signal" with the NYSE at 4970 and a confirmation in June as the index crosses above zero in June at 5564.  Yes the conservative player would have missed about 600 points of gains but the market moved up above 6700 over the next six months. 

next column

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-Continued from Previous Column-

Once again we have about 3 years of whipsaw period where we should be cautious but the moving average is flat so not too much worry.  We get a good sell signal in October 2007  with the index above 10,00o. As the gap widens during  November and December the NYSE is in the 9000s.  January as we cross below the zero line we get another warning we can get out  at 9000,  February we can get out at 8900.  April, May and June although the annual rates of return are negative and flashing red warning signals the index is at  9200, 9400 and 9000 respectively. At this point we have had 8 months of warnings and we could have gotten out at almost any point with less than a 10% loss (from the peak).  If we had gotten in at the conservative buy signal June 2003 we would have been up  between 60% and 70%.

So it is no surprise when in July the market takes a dive down to 8400 (even there we are up 51%) .  And we have had a whole years warning by October as the NYSE drops to 5700. Where we are about even with our entry point but...  five years later.

At this point we are closer to a buy signal than a sell signal.  The NYSE ROC is lower than at any other point on our chart.  So the question remains what to do now?  Actually looking at the NASDAQ in the 2002 - 2003 time period might be a good clue as it looked much like the NYSE does now. What happened in 2002 was a false buy signal followed by another leg down.  So that is very possibly what we will see now.  The major question is whether we will see a protracted downturn like the "Great Depression" or simply a nasty  recession like the 1970s.

For more information the NASDAQ ROC Chart and How to Decide if the Rally is Real or Not .

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.