Updated 11/18/2008

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:

As anyone who isn't living under a rock knows the NYSE  is down sharply last month. It was down -43.11% on an annual basis! On a monthly basis, it was down - 25 %.  This month wasn't nearly as bad. It was "only" down 7.58%  or slightly less than the market earns in an average year. 

When you think about losing an entire year's gain in a month it is put into perspective. Put another way, if we are lucky and the market is average, over the next 12 months we might get  back what the market lost this past month.

At this point the market is down -46.02% compared to 12 months ago. The good news is that if you look at the line in the ROC chart you will see it starting to level out.  However, this is not a price chart, the longer it stays at that level the more we are losing. Think about it this way.

Suppose we lose 2% a month for a year. At the end of the year the ROC will be at -24%  if on the 13th month it is still reading -24% you have actually lost another 2% of your investment!  This is because the first month's loss has now fallen out of the calculation and so if the market price was flat you would be down -22% because you are now measuring from a different starting point, i.e. a point that is already down 2% from where it was in the beginning.   

A typical correction is between 20% and 30% so with the market currently down over 46%, we are way below a normal correction. We are currently at historic levels and we aren't out of the woods yet.  Legendary market trader W.D. Gann believed that market prices have both a time and a price component.

In other words,   they have to work their way through a correction like this and so you won't wake up one day and everything is back to normal with stocks just jumping back up to where they were.  It makes sense because market psychology plays such a big part in the price at any given time.  It will take time for market participants to regain their confidence and slowly begin to commit funds to the market again.

I still stand by the timing projection that the market has until at least April or May of next year before we can expect it to even begin to find a firm bottom. This is not to say it will steadily go down from here.  Bottoms are full of volatility. Volatility is currently at record levels with markets moving record amounts in both directions in a single day.  Investors are very skittish and it doesn't take much to move them in either direction.

One of the reasons we still have a way to go is because of all the bad loans that need to get worked out of the system. It is also partially because of the ROC chart.  Just look at how far below the moving average it is.  It will take time to catch up with the moving average and even when it crosses above it, it will still be in negative territory so it will take time to move above the zero line.

With typical corrections lasting 18 months to three years we theoretically could have two more years to go.  So at this point the best we can hope for is that the market will stop falling and mark time (move horizontally) for the next seven months to two years.

At the moment the market is trying to sort out its true valuation.  For more information on how to decide what a stock's true value should be see How Much is a Stock Really Worth? What to Do Now?  and What is the Real Price Earnings Ratio and How do I use it?

Also see the  NASDAQ ROC Chart for more information.

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.

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