Despite its simplicity, Rate of Change (ROC) is a very efficient technical oscillator showing change of price between definite periods of time in the per cent form.
ROC is measured by comparison between present price and previous price N periods ago. ROC periods can involve different intervals from minute to month.
The Rate of Change (ROC) – is a simple technical indicator measuring change of price for previous period against the price N periods ago in the per cent form. In contrast to the Momentum indicator measuring paces, which is defined by difference between prices for certain time intervals, ROC indicator value is measured as quotient from fraction of Close price for a day ago (Close(i)) to Close price of previous period (Close(i-n)). On chart the line of ROC and Momentum values is changed one to one except that support line for ROC is 0 and support line for Momentum is – 100 (pic.1)
Pic. 1 - ROC and Momentum indicators
Close(i) — Close price of previous bar;
Close(i-N) — Close price n bars ago;
N - indicator's period;
i - Current bar number
ROC indicator relates to anticipating figures, however, in terms of logic, if price factor is removed from calculation, the indicator stops operation and anticipation does not work as well. Still the point of anticipation is the following: when trend starts losing its force and slows down, the indicator's values begin pivoting, whereas price still can continue its movement along trend. In other words, as many other oscillators, ROC shows divergence and convergence. Of course, many things depend on parameters chosen by trader.
Signals sent by Rate of Change (ROC)
Signals for trend. Crossing of zero line from bottom to top acts as signal for purchase, from top to bottom – signal for sale. It is important to remember that the less chosen period, the more false signals.
Overbought/oversold. If the indicator forms extremely high values (peak), and then reverses downward, it speaks for continuation of tendency, which speeds starts slowing down and trend starts attenuation. And vice-versa, if ROC form extremely low values (lacuna) and start growing, it says that bears get exhausted but trend still is in the effect. It is not recommended to open positions against major tendency, because market can still retrace. But under flat consolidation, such approach will provide good signals for sales and purchase.
Divergence/convergence. Bullish divergence occurs when a higher maximum of price is not confirmed with a higher ROC value. Bearish convergence when a lower minimum value of price is not confirmed with a lower ROC value.
ROC is a simple and universal signal for measuring pace. It can work both as the indicator of trend's direction and as oscillator with overbought/oversold zones. Drawbacks are that it responses twice to price (in numerator and denominator) that enhances sensibility of the indicator to changes in price. But this disadvantage is eliminated through using smoothed ROC, matching values of exponential moving average rather than values of price.