How To Use The Coppock Indicator In Investing

The Coppock indicator was invented by Edwin Coppock, a US investment adviser. He designed the indicator to do only one thing.

This was to indicate when it was time to buy long-term holdings near the bottom of a bear market.

Before we look at the calculation and interpretation of the indicator, we should understand what Coppock was trying to do. Most investors come into the stock market in the closing stages of a bull market. They then suffer losses in the following bear market. Many take their losses at some point and swear off the stock market for life. A few learn the lesson and work at getting back into the market early in the next bull market, when risks are much lower.

Coppock pointed out that even a superficial look at long-term charts of stock markets will show that from time to time there are deep valleys, when it would have been perfect to buy. Beginners never do this, but some professionals calmly wait for these times and take advantage of them. Coppock made this point very strongly when he pointed out that most people buy on good news and sell on bad news. Our aim should be to buy early in bull markets with the professionals, not in the high-risk terminal phase of the bull market when rampant speculation sucks the punters into buying on greed and hope. Coppock designed his indicator for just this purpose.

Coppock described the calculation of the indicator and its use at some length in his paper Realistic Stock Market Speculation, which seems to have been last revised about 1967 and has long been out of print. The indicator was designed for the Dow Jones Industrial Average and is calculated monthly. It has been found to be useful for almost any stock market index.

The steps in its calculation are:

  • Calculate the percentage change between the index value at the end of the current month and its value 14 months earlier.
  • Calculate the percentage change between the index value at the end of the current month and its value 11 months earlier.
  • Total the two percentages.
  • Calculate a 10-month weighted moving average of the total of the two percentages.

Technically, the Coppock indicator is only a very specific form of the general indicator type known as a long-term momentum oscillator. In other words, it measures changes in the speed of price change in the stock market. Being an oscillator, the Coppock indicator will swing between positive and negative values.

The signal for long-term investors to begin buying is when the indicator turns up when it has fallen below the zero line. In other words, the signal is when it becomes less negative than it has been. This is shown in the figure below:

Coppock indicator signal

You can calculate the Coppock Indicator for any broad stock market index using this excel workbook: Coppock Indicator. In this worksheet, I have also calculated the Coppock indicator for Sensex. You can see the exact buy points the Coppock Indicator would have suggested in the excel sheet as well on the figure below. So you can see, it works quite well.

Sensex Coppock Indicator

 

Experience has shown that the Coppock indicator can give a signal a few months earlier than the exact bottom of the bear market. It can also give a signal a few months later than the exact bottom. It was never intended to be a precise timing indicator to pick the bottom of the market cycle. Instead, it was only designed to indicate a period of low risk when long-term investors might start buying. Therefore, it is one more tool that we can use to help us identify the level of risk as input for our strategy for deciding what proportion of our capital should be invested in stocks.

Coppock’s strategy for signals on his indicator was to start buying strong stocks for long-term appreciation, not for short-term speculation. Strong stocks are stocks that are trending up. They will have moved out of a downtrend or of a sideways price pattern by rising above a significant peak on their charts. If we cannot find any of these stock charts, then the signal may be premature and we should wait until they appear. Following Coppock’s advice to buy stocks that are trending upwards should not be disastrous. These stocks could well be the leaders of the next bull market. However, if any of their upward trends fail by dropping below a significant trough on their charts that will signal us to execute our sell stop.

While the Coppock indicator has a very good record, it is not infallible. Coppock was quite clear that all methods may at times fail in some markets. Thus, he believed that different methods must be used in parallel as a means of reducing risk.

Being able to see which signals were premature and which were well-timed in hindsight is of little use. What is important is the action we take from signals when they occur. My view is that investors should have acted on them by looking to buy uptrending stocks. If there were uptrending stocks, then the signal really was early. However, if it were possible to find some strong stocks, an investor ought to have begun building positions in those stocks. If some had weakened and hit sell stop levels, they would have been sold. 

When some people see this evidence, they fall in love with the Coppock indicator. They then try to use it for everything. A common question is whether it will work for sector indexes and for individual stocks. Also, some beginners ask whether the Coppock indicator can be used for selling signals as well. The answer is there is no research.

The Coppock indicator is not magic. It is simply a specifically optimised long-term momentum oscillator, which was created for one purpose. Also, timing the buying of individual stocks is quite a different problem to assessing general market risk. The technical analyst toolbox contains many other methods, which may be even better than the Coppock indicator in these situations.

When using technical analysis, it is important to always understand how the various indicators work. Most of the time, they can be used fairly mechanically. However, at critical times they may pose challenges that require us to understand how a situation may be different to normal. The Coppock indicator generally gives good, clear signals when bear markets unfold steeply without large prolonged rallies. But there have been occasions when a bear market has taken rather longer than normal and descended rather more slowly and unevenly. When this happens, there is a risk that the Coppock indicator may give several premature signals before the final bottom is reached.

So this is how the Coppock Indicator should be used for investing. I hope you find it useful.

-inspired by Colin Nicholson

 

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