The Price Rate of Change (ROC) indicator, also known as rate of change or ROC indicator, is a momentum-based technical indicator that determines the percentage change between the current price of a security and the price a particular number of periods ago. The ROC indicator is graphed against zero, with the indicator moving above the zero line into positive territory when the price movements are upwards, and moving into negative territory in case the price changes are downwards.
In terms of technical analysis, momentum generally is used to denote the speed at which an upward trend or a downward trend is moving. Usually, momentum drops quite significantly before a certain trend is reversed.
eed and come to a halt temporarily before it begins moving in the opposite direction. By determining the momentum of a security, one can identify potential reversals in a trend. Momentum is usually calculated as the difference between the closing price after a certain trading period and the closing price of the asset a few trading periods before.
The ROC indicator is useful in spotting divergences, overbought and oversold positions, and centerline crossovers — when the moving average convergence/ divergence oscillator (MACD) line moves above the zero line into the positive territory.
Calculating the rate of change indicator
Since ROC is the percentage change between the current price with respect to an earlier closing price n periods ago, here’s how it is calculated:
ROC = [(Today’s Closing Price – Closing Price n periods ago) / Closing Price n periods ago] x 100
The steps in calculating the ROC are
1. Pick a value for n
2. Find out the closing price of the security after the latest trading period
3. Note down the asset’s closing price n periods ago
4. Put the security prices from the previous two steps in the formula for ROC
5. Calculate a new value of ROC after each trading session
The most important step in determining the rate of change is choosing the value of “n”. While traders looking at a security in the short-term may pick a small value of n — for instance seven or eight, investors with their eyes on the long-term might select a bigger value of n such as 250 or even 300. The value of n is the number of periods with which the current price is being compared.
One should note that a smaller value of n will make the rate of change more sensitive to price changes in the short-term — as such this leads to a greater probability of false signals. Meanwhile, if you choose a larger value of n, the ROC indicator would be slower to react. However, the signals given by the indicator would be more meaningful when they appear.
Interpreting the rate of change indicator
Usually, prices are rising when the ROC indicator is positive. The ROC expands further in the positive territory when an advance in the security’s price accelerates. Meanwhile, prices are falling when the ROC indicator drops below the zero line, diving deeper into negative territory as the security slide accelerates.
There is no upward threshold on the ROC indicator — it may soar as high as possible during an advance. However, there exists a downward limit — the price of an asset may decline only 100%, which would mean relegation to zero. Despite the lopsided nature of the boundary limits, the ROC indicator gives extremes that are identifiable and signal overbought and oversold conditions for an investor.
The overbought and oversold levels are not fixed — they would change even as a security is being traded. Investors should check how changes in ROC values impacted trend reversals in the past. Usually, traders would find both positive and negative values of the ROC indicator at which the price of a certain security appears to reverse quite regularly. In case the ROC value touches those extreme points again, an investor would be on alert and look for the asset’s price to begin reversing so that the ROC signal can be confirmed. When the rate of change signal is confirmed with a price reversal, a trade might be considered.
As with all technical indicators, the ROC indicator should be used in conjunction with other tools of technical analysis. One should remember that even if positive readings are less than before, a positive ROC value still indicates a price increase and not a price drop. Moreover, when the price of an asset consolidates, the ROC value moves towards zero. One must be careful during such times as this might lead to multiple false signals.