What is Rate Of Change Indicator(ROC)?

The Price Rate of Change (ROC), also known as the rate of change, or ROC indicator, a momentum-based technical indicator that measures the percentage change in the current security price and its price at a specific time period. The ROC indicator graphs against zero. If the price moves are upwards, the indicator will move into positive territory. If the price drops, the indicator will move into negative territory.

Technical analysis uses momentum to indicate the speed at which a trend is moving upwards or downwards. Momentum usually drops very quickly before a trend is reversed.

It can temporarily halt the trend's momentum and then resume its normal course. You can spot potential reversals by determining the momentum of a security. Momentum is often defined as the difference in closing prices after a specific trading period and closing prices of the asset within a few trading periods prior.

The ROC indicator can be used to spot divergences, overbought or oversold positions and centerline crossovers -- when moving average convergence/divergence oscillator moves above the zero line into positive territory.

Calculating the rate of change indicator

x

Here's how ROC is calculated.

ROC = [Today's Closing price - Closing price n periods ago]/ Closing price n period ago] x 100

These are the steps to calculate the ROC

1. Choose a value to represent n

2. Determine the closing price for the security following the most recent trading period

3. Notify the asset's closing prices n periods ago

4. Add the security prices from the two previous steps to the formula for ROC.

5. After each trading session, calculate a new value for ROC

The key step in determining the rate at which the security will change is to determine the value of "n". The most important step in determining the rate of change is choosing the value of "n". While traders may choose a smaller value n, such as seven or eight -- investors who are looking long-term might pick a larger _n value like 250 or 300. n is the number of periods in which the current price has been compared.

A lower n value will make the rate change more sensitive to short-term price changes. This can lead to false signals and a higher chance of errors. The ROC indicator will react slower if you use a higher value of n. The indicator's signals would still be meaningful if they appeared.

Interpreting the rate-of-change indicator

Normally, prices rise when the ROC indicator becomes positive. When the security's value rises, the ROC indicator expands even more in the positive zone. Prices fall when the ROC indicator falls below the zero line. As the security slide accelerates, they dive deeper into negative territory.

The ROC indicator does not have an upward threshold. It may rise as high as it can during an advance. There is a downside limit to the ROC indicator. An asset's price may fall only 100%. This would lead to relegation back to zero. Despite the lopsided nature the boundary limits, ROC indicators identify extremes that are easily identifiable and indicate overbought or oversold conditions to investors.

Overbought or oversold levels cannot be fixed. They can change as security trades. Investors should examine how past changes in ROC values have affected trend reversals. Usually traders will find both positive or negative ROC indicators at which the price for a security seems to reverse. Investors should be alert if the ROC value reaches these extreme points again. This will allow them to look for a price change that would confirm the ROC signal. A trade may be possible if the rate signal has been confirmed by a price reversal.

Conclusion

The ROC indicator should always be used with other technical indicators. Remember that even though positive readings may be lower than they were before, a positive ROC number still indicates a price rise and not a drop. The ROC value will move towards zero if an asset's price consolidates. This could lead to false signals and one must be cautious.