McClellan Chart In Focus: Stock Market Showing Another Example of “Rogue Wave” Behavior – By Tom McClellan


Chart In Focus

The term “rogue wave” applies to strangely massive waves which occur in the ocean.  And the same physics appears to show up in the movements of stock prices.

Oceanographers who study this phenomenon have observed that it is not just about a wave being very tall above the mean sea level.  A rogue wave does have a crest, and it also has an adjacent trough which is approximately the same depth below normal sea level that the crest is above it.  That is what makes a rogue wave so destructive to ships.

I first began to contemplate this topic as it relates to the financial markets after reading an article in National Geographic magazine about the Maxwave Project.  It included this chart, which is an actual plot of wave height measured in the ocean:

Maxwave plot

The operating hypothesis behind the formation of large rogue waves in the ocean is that a rogue wave “borrows” energy from adjacent waves, making them smaller, but making the rogue wave bigger.  And eventually the rogue wave passes, allowing the chop to return to its normal amplitudes above and below sea level.

In looking at that chart, it occurred to me that I had seen this plot before.  So using a little bit of charting magic, I created this comparison:

Maxwave plot versus 1929 crash

The key point to adapting this principle to the financial markets is that the notion of “sea level” is different.  It does not have to be a flat price level, but rather perhaps a regression line which may be sloped upward or downward.   Such is the case in that chart of the 1929-32 rogue wave event.  And it is fun that the stock market “waves” before and after the big event looked a lot like the Maxwave plot.

If one prefers, one can “flatten out” the stock market by portraying prices as the distance from some moving average, as opposed to raw prices.  Here is an example of that technique, comparing the January 2018 “Short VIX Crash” to the Maxwave plot:

DJIA rogue wave 2018

And here is a chart of the raw DJIA values from the current episode, again compared to that Maxwave plot:

DJIA vs. Maxwave plot

If this interpretation is correct, that we are seeing another example of a rogue wave in the stock market, then the conclusion is that we should see some sort of return to “sea level” once the bottom is in.  What price level constitutes “sea level” for this episode is a harder question to answer in advance.  And following that return to sea level, it is also possible that a new price trend could develop, upward or downward, which changes what the future “sea level” could look like.

From the first chart, though, if my hand-drawn middle line is approximately correct, then the bounce to get back to the current “sea level” would mean getting the DJIA back initially to around 26,000 to 27,000, just as a return to my guess about what sea level is for this instance.  And that is just a guess.

To see how rogue waves have played out in other market scenarios, check out the prior articles cited below.

Tom McClellan
Editor, The McClellan Market Report

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About the author

Sherman and Marian's son Tom McClellan has done extensive analytical spreadsheet development for the stock and commodities markets, including the synthesizing of the four-year Presidential Cycle Pattern. He has fine tuned the rules for interrelationships between financial markets to provide leading indications for important market and economic data. Tom is a graduate of the U.S. Military Academy at West Point where he studied aerospace engineering, and he served as an Army helicopter pilot for 11 years. He began his own study of market technical analysis while still in the Army, and discovered ways to expand the use of his parents' indicators to forecast future market turning points. Tom views the movements of prices in the financial market through the eyes of an engineer, which allows him to focus on what the data really say rather than interpreting events according to the same "conventional wisdom" used by other analysts. In 1993, he left the Army to join his father in pursuing a new career doing this type of analysis. Tom and Sherman spent the next 2 years refining their analysis techniques and laying groundwork. In April 1995 they launched their newsletter, The McClellan Market Report, an 8 page report covering the stock, bond, and gold markets, which is published twice a month. They utilize the unique indicators they have developed to present their view of the market's structure as well as their forecasts for future trend direction and the timing of turning points. A Daily Edition was added in February 1998 to give subscribers daily updates on their indicators and also provide market position indications for stocks, bonds and gold. Their subscribers range from individual investors to professional fund managers. Tom serves as editor of both publications, and runs the newsletter business from its location in Lakewood, WA.