Looking Deeper into Levels of the Rate of Change Indicator

The rate of change oscillator conveys a good deal of information in and of itself, but it provides more information if the time is taken to study the market action that errated the current reading.
More specifically, each day’s new rate of change indicator level actually involves two variables: the current day’s change in price level and dimction of movement, and the level and direction of the price movement of the day that is being removed from the calculation being made.
If the day being removed was a day of market decline, rate of change measurements will turn upward even if today shows no gain in price, for as long as it shows lesser loss than the day being removed. Therefore, if weaker market periods are being eliminated from rate of change calculations, rate of change levels tend to rise easily, often before price trends tum upward. If today happens to be a rising day and the day eliminated from the calculation was a falling day, rate of change measurements might rise rapidly.
Conversely, if the days being removed from your calculations were days of market advance, it will be more difficult for your rate of change indicator to gain ground. During strong market periods, rate of change indicators are likely to track sideways, but at relatively high levels. It might appear at such times that negative divergences are taking place, but if you examine the data stream carefully, you might notice that the stock market is not really weakening at all and that, in fact, the ability of its rate of change readings to remain high is a sign of strength.
Let’s go back to our data September was a period of sharply declining stock prices, so rate of change levels rose quickly in October, even prior to price gains of any significance. Not until the turn of the month into November were the days being eliminated in the calculations rising market days. Rate of change measurements remained flat, though high for several weeks. The inability of rate of change measurements to advance further was, in this instance, not a sign of market weakness, but rather simply a reflection of the ongoing strength that had been maintained over several weeks.
Relative strength readings did not seriously begin to fail until the end of 2001, when, after a dip, prices rose to new highs while rate of change measurements clearly failed to do so. Prices and rate of change measurements declined simultaneously early in 2002, the decline preceded by the negative divergence that had developed between December 2001 and January 2002.
The first dip down in early December, accompanied by declines in the rate of change indicator, was not necessarily indicative of a more negative market climate. Even the strongest market advances have periods of consolidation. You might notice that at no time did rate of change levels decline below 0 during December. However, a negative divergence, with more bearish implications, did develop at year end.
What made tlh negative divergence more significant than the flattening of the rate of change indicator during October and November? Well, for one thing, rate of change readings were no longer tracking at high levels, declining to near the zero line. For another, patterns of price movement had changed, with price trends flattening. As a third consideration, there was very little time between the time that the rate of change failed to reach new peaks that would have confirmed new highs in price, and the rapid turndown in price levels from the early January peak.
Again, declines in rate of change readings and the presence of negative divergences are more significant if they are accompanied by some weakening in price trend. Double-top formations in price (two peaks spaced a few days to a few weeks apart) accompanied by declining double top formations in rate of change measurements can be quite bearish.
Conversely, rising patterns in rate of change measurements are more significant if they are confirmed by a demonstrated ability of the stock market to turn upward. Double-bottom stock market formations, spaced a few days to a few weeks apart, accompanied by rising rate of change readmgs often provide excellent entry points.