The Rate of Change (ROC) is a price-based indicator designed to measure the rate at which the price changes from one period to another. The measure of the current price in relation to a defined look-back period is the typical rate of change definition.

However, when expressed as a percentage, ROC can help traders determine not only momentum, but also overbought and oversold conditions as well as the trend direction. ROC is a momentum oscillator; other indicator types similar to ROC include MACD, RSI and ADX.

Any financial asset can theoretically advance indefinitely, but the maximum drop is to zero. This essentially means that while negative ROC values have a limit, positive ROC values are unbounded.

ROC Calculation

ROC is calculated in such a manner that traders can assess how the price has changed compared to a defined look-back period. The rate of change formula is as described below:

ROC = [(Current Close – Close n periods ago) / (Close n periods ago)] X 100

*Where ‘n’ is a ‘user’ defined number representing the number of periods ago that the price is being compared to.

The default ‘n’ on most platforms is 14, but 9 and 25 are also common among many traders. In many cases, longer-term traders usually select a period as large as 200. While a smaller number will react to prices faster, it may lead to choppy or false signals.

On the other hand, a larger number will react slowly to price changes (the ROC will be smoother), but this may lead to more reliable signals when they occur.

It is important to understand the volatility nature of the underlying asset to be analysed. As well, traders can also use shorter ‘n’ values on higher timeframe charts, such as daily and above; and longer ‘n’ values on lower timeframe charts, such as 1 hour and below.

Reading the ROC Indicator

With ROC seeking to compare prices from a past defined period, the indicator values will either be above zero or below it. Zero will act as the centreline. When indicator values hover around zero, it will denote a consolidating market. A reading above zero will imply a bullish sentiment in the market; whereas a reading below zero will imply a bearish sentiment in the market.

Although used as an oscillator, the ROC has no defined overbought and oversold levels. Traders pick out such zones by observing the prior extreme levels the ROC printed in relation to the price of the underlying asset.

ROC and Momentum

ROC and momentum are two different indicators designed to help traders decipher a similar price element – momentum. Both indicators tell a similar story and can be used interchangeably.

The main difference between the two lies in their calculation. ROC values are expressed as a percentage, while Momentum Indicator values are absolute values. Also, ROC has 0 as the centreline, while the Momentum Indicator has 100 as the centreline.

Other technical analysis tools that help traders decipher momentum information include MACD, RSI and ADX. MACD traders watch out for its histogram to determine price momentum. A rising slope of the histogram denotes increasing bullish momentum, while a falling slope implies increasing bearish momentum.

RSI has a centreline at 50; a cross above 50 indicates that an uptrend is gaining momentum, whereas a cross below 50 indicates that the prevailing downtrend is more momentous.

ADX is a non-directional momentum indicator that quantifies trends. ADX prints values of between 0-100; with values above 25 indicating that the prevailing trend is gaining momentum, whereas values below 25 show that the prevailing trend is weak.

Using ROC in Trading

Here is how to trade the signals generated by the ROC indicator:

  • Overbought and Oversold Conditions

Momentum indicators are particularly ideal for trading ranging markets because they help forecast turning points accurately. Momentum generally refers to a trend continuing its course, and in a ranging market, if a trend starts to lose momentum, it is best to start looking for opportunities to trade in the opposite direction. Peaks and troughs can occur after a certain time has elapsed or when a certain percentage move has been made. As an unbound indicator, ROC gives a clear picture of when to anticipate such turnarounds based on previous printed indicator levels.

  • Breakouts

Breakouts occur with strong momentum, and what better indicator to qualify breakouts than the ROC. When the price is consolidating or ranging, ROC will print flat values. A sustained sharp rise or fall will confirm that the breakout trend will be sustained going forward.

  • Zero Line Crosses

A zero-line cross on the ROC is an indication that a new trend is forming. A cross of the zero-line from below indicates that a bull trend is now in place, whereas a cross from above indicates that a downtrend is now in place. As mentioned above, it is important to consider the asset volatility and timeframe chart to minimise false or whipsaw ROC signals that come from zero-line crosses.

  • Divergences

Divergences are great for timing market turning points, and with the ROC being a momentum indicator, it can deliver accurate and compelling divergence signals. Bullish divergence will occur when the price is forming lower lows, but the ROC is printing higher lows. This will be a signal that the downtrend lacks momentum and a trend change to the upside is about to occur. Similarly, a bearish divergence will occur when the price is forming higher highs, but the ROC is printing lower highs. This will be a signal that the uptrend lacks momentum and a trend change to the downside is about to occur. It is important to note that sometimes, a divergence signal may take a little longer to play out, and it is important to seek confirmation from other tools or even price candlesticks to identify optimal trade entry points.

ROC and Other Technical Analysis Tools

As pointed out above, ROC may sometimes deliver early or late signals. It is, therefore, important to seek effective indicator combinations with the ROC that will help generate confluence signals.

Here are some of the best ROC indicator combinations strategies:

  • ROC and Stochastics

This combination is best for timing trend reversals. When the ROC delivers a divergence signal, traders can watch out for stochastic crosses in overbought or oversold zones to pick out optimal entry points in anticipation of a trend change. For instance, in the case of a bullish divergence, the best entry point would be a stochastic cross in oversold territory.

  • ROC and Moving Averages

The ROC zero-line cross can sometimes deliver vague signals to confirm a trend change. To confirm trend reversals, traders can combine the ROC with two moving averages. For instance, when the ROC has just crossed the zero-line from above to signal a downtrend, additional confirmation will be received when the faster-moving average crosses the slower moving average downwards.

Trade Using ROC at Friedberg Direct

Here is why you should trade using the ROC indicator at Friedberg Direct:

  • Numerous Indicators – Combine the ROC with any other indicator of your choice from a selection of over 150 technical analysis tools available at Friedberg Direct.
  • Multiple Assets – Pick out trade opportunities using the ROC on over 100 assets available at Friedberg Direct that include Forex, Stocks, Indices and Commodities.
  • Demo Account – Develop, test and tweak your ROC strategies at Friedberg Direct without putting any money on the line with a demo trading account.

** Disclaimer – While due research has been undertaken to compile the above content, it remains an informational and educational piece only. None of the content provided constitutes any form of investment advice.

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