- Rate of change refers to the acceleration or deceleration of an underlying speed.
- This data can be used to analyze the strength and direction of an underlying economic indicator, including any possible reversal points.
- A high rate of change would indicate a strong momentum of the trend, and it is likely to continue until the rate of change begins to decline.
What is Rate of Change?
Rate of change is a very important concept for financial analysts and economists. The average investor does not use the concept as often, but an understanding of the tool is still important.
Rate of change refers to the acceleration or deceleration of an underlying speed. For example, a car that is driving forward at 50mph and continues to drive at 50mph will have a rate of change of 0. The car is still progressing down the road, but it is traveling at a consistent speed. If this car speeds up to 60mph, then the rate of change would be 20% as it is now progressing down the road at a faster rate. (10mph/50mph = 20%) If this car decides to slow down to 25mph, then the rate of change would be -50%. (-25mph/50mph = -50%) This car is now traveling down the road at half the original speed, so there was a negative 50% rate of change.
Recent Rise in Inflation
This concept can be applied to various economic indicators and a stock’s or asset’s price movement. Most recently, everyone has been aware of the recent rise in inflation. Inflation is historically around 3% per year. Still, we are all well aware that we have been dealing with higher-than-average levels. Suppose inflation was steady at the 3% level. There would be a 0% rate of change in the metric.
However, inflation peaked in June of 2022 at just above 9%, so there was a 300% total rate of change. A closer look at the monthly breakdown will reveal that the trend started to speed up in the spring of 2021. We saw increases of 1.00%, 1.50%, and 0.80% for the months of March-May of 2021. Inflation continued to increase afterward. Still, it was more consistent and at a slower rate of change March-May of 2022 actually saw a slight dip, then a reversal back to the previous level of inflation, and the inflation peak followed this period in June of 2022.
The slowdown in the rate of change could have been indicative that we were approaching a reversal point for inflation. Of course, it is impossible to predict exactly what the future holds, but this slowdown did present a possible top for inflation. We very well could have continued to see an increase in inflation after June of 2022, but the slower rate of change means that we were getting closer and closer to the top.
Strength and Momentum of a Trend
A more robust rate of change indicates the trend has stronger momentum and is not likely to stop on a dime and reverse. Typically, the underlying indicator or price would need to slow down before the overall direction will change. It is important to note acceleration/deceleration refers to the speed of the current trend and not the overall direction. It is very possible to accelerate to the downside and decelerate to the upside.
Predicting Economic Indicators
This analytical process can be used to predict economic indicators such as Inflation, GDP, Unemployment, etc., and being able to identify the strength and direction of these indicators may allow investors to identify future possibilities. For example, identifying a high rate of change in the US GDP may allow investors to feel confident in their growth investments.
On the other hand, a decline in the rate of change may provide an investor with the clues necessary to shift more defensive in preparation for a potential economic slowdown. Stock and Asset Prices can also be evaluated using the rate of change as analysts try to predict the future trend. Of course, this method is not 100% guaranteed, and there certainly could be other variables that will affect estimates, but it is a handy tool to be aware of for every investor.
Investing can be a very mathematical process, and this little bit of calculus may prove to be beneficial for identifying important trends and reversals.
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We hope you learned something today. If you have any feedback or suggestions, we would love to hear them.
Zachary A. Bachner, CFP®
with contributions by Robert L. Wink, Kenneth R. Wink, and James D. Wink