The Rate of Change [ROC] is a basic momentum indicator with one of two possible calculations, depending on the charting package used. On ProfitSource [PS], the weekly ROC calculation is:
- 100 x (Price today / Price x-weeks ago)wi
This calculation creates an equilibrium line at 1, while the second calculation has that line at 0.
In terms of movement, momentum can surge out of important market bottoms as shorts cover their positions and money waiting on the sidelines initiates new buys. It’s not uncommon for the ROC to move to extremes then settle down into more moderate oscillations as the intermediate to longer term trend continues.
The longer the bullish trend continues the more likely you will begin to see divergences in ROC; price peaks continue higher while ROC peaks experience lower highs. These divergences can remain in place for extended periods of time and do not represent trading signals on their own.
Before viewing current conditions for the Dow Jones Industrial AverageSM (INDU), consider the following:
- Tis view provides a bigger picture of market trends.
- Traders should be aware of their preferred timeframes and where longer-term trends fit.
- Recognize that ROC divergences can remain for extended periods of time.
This week’s charts include compressed weekly views of INDU in two segments:
- 1997 – 2012
- 1981 – 1996
The time periods capture the strong secular bull that occurred during most of the 1980’s & 1990’s, along with the secular bear that followed. By viewing compressed line charts with a greater time interval, technicians can observe bigger trends that are emerging.
Traders are impacted by secular conditions because they behave differently. In general, traders should expect:
- More bullish years than bearish in secular bulls,
- More volatility, with bullish years gaining slightly more in secular bears, and
- The potential for extreme declines in secular bears.
For more on the topic of secular conditions, consider Ed Easterling’s book, “Probable Outcomes”.
When viewing a compressed long-term chart such as the ones provided, traders should consider how the bigger picture relates to their preferred trading timeframes. For instance,
- Very short-term traders (focus on intraday and daily moves) may need to avoid long-term charts, particularly when performing any trade analysis. However, moving up one interval on a chart may alert them to changing conditions.
- Swing-oriented traders may strike a balance between focusing on preferred timeframes and a periodic assessment of longer-term ones to avoid tunnel-vision.
In all cases, the best views to assess will depend on the individual’s style of trading.
Since divergences can persist they don’t feel particularly helpful when being formed. Regardless, they should need to be considered when performing market assessments. Momentum divergences represent a counter-argument to the existing trend for a “weight of the evidence” approach to analysis. When other distinct tools begin to line up on the side of the divergence, traders may need to pare back on strategies that were effective when the trend had more strength.
The weekly chart for INDU displays an ROC divergence in place for 31 months. This divergence excludes the peak formed by ROC during the first surge off of the March 2009 bottom. Additional specifications for the two charts include:
Specs for Weekly Line Chart of INDU:
Price & Volume are on a log scale
Volume with 20-week SMA
34-week ROC with 21-week SMA
ROC divergence > 12 months labeled
Extreme ROC levels noted by horizontal lines at 1.25 (bullish) and 0.85 (bearish)
Figure 1: Weekly Line Chart of INDU from 1997-present.
Although a shorter-term divergence appears in Figure 1 from 1997-1998, only those existing for 12 months or more are labeled. To gain a better sense of the implications of such a divergence, similar divergences from 1930 to the present day will be provided next week.
Figure 2 displays weekly closes from 1980-1996 with a 30 month divergence from 1991 through 1994 highlighted. In this instance neither the bullish surge in ROC nor the corrective move down that followed went to the extremes.
Figure 2: Weekly Line Chart of INDU from 1980-1996.
More to follow next week.
Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
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