Rate of change (def): The speed at which a variable changes during a specified period of time.
When I am asked about advanced options trading strategies, I invariably discuss rate of change, as it can be a powerful predictor of future momentum. As we all know, it is difficult to predict a top or bottom, but from a mathematical perspective, we can use it to identify probable turning points, ride momentum, and enjoy significant gains.
Here’s how it generally works: Look for a change in trend on the chart, calculate the rate of change to help determine momentum, and estimate its trajectory.
When evaluating stocks, we can use the price rate of change to identify shifts in the trend. As we see from the chart below, it’s often a leading indicator that tells us a move is about to happen (so get on board quickly!). Like I said above, riding the rate of change can be quite profitable, but it must be confirmed by other indicators. For instance, we would like to see volume trends and oscillators moving in alignment with it. The more indicators that align, the more confidence we have.
We can also use the rate of change to evaluate other metrics, including earnings. For the last several quarters, the US economy has been in an “earnings recession,” with weaker earnings quarter after quarter.
There are numerous reasons for this: lower energy prices, a stronger dollar and weak global demand. These pressures have reduced GDP over the past few years, but I think the most recent earnings were the bottom, as we see the rate of change declining.
It is certainly a welcome change. Markets may have already priced in more profit downside, so the worst may indeed be over. Further, if company earnings start to expand, it will have a ripple effect and eventually show up in higher GDP. So basically, this inflection point could be a game changer.
While there are many different ways to analyze data, the rate of change offers us excellent insights as to when a trend change is about to happen. Pay attention to it, and confirm what you see against other indicators.
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