The rate of change or ROC is a technical indicator that is classified as a momentum indicator. The ROC is similar in its behavior as an oscillator and falls in the same category of indicators such as the RSI or the Stochastics oscillator. Still, there are some significant differences between the ROC and other similar indicators.
The Rate of Change indicator is typically used to measure price or volume. Thus, when referring to the ROC, it is quite possible that you will come across either price ROC (PROC) or volume ROC (VROC).
Depending on what markets you are trading, you can use either both or just one. In the forex markets, the price rate of change is most widely used, while for stocks and futures, you can use the VROC in addition to the PROC as well.
In this first part, we take a brief introduction to the Rate of Change indicator. In the next series, we will look at how you can trade with the ROC indicator.
How does the ROC indicator work?
As the name suggests, the rate of change indicator measures the rate of change in prices compared from one period to the next. Based on the look back period that is set, the ROC measures the current price to ‘n’ periods ago and measures the pace at which price is changing.
The ROC is useful to determine the momentum of the security being analyzed. Typically in a bullish or bearish market, the momentum of the price leads the way. This tells the trader weather the current trend will continue or not.
The ROC moves across positive and negative values. When momentum in the security is rising, the ROC is positive, and when the momentum is slowing, the ROC turns negative.
Typical to most oscillators, the ROC can be useful to spot divergences. In this case, the divergence between the price and the rate of change can be an early indicator of a potential pullback in prices.
The ROC has a rather simple calculation making it easy to work with.
The ROC is nothing but the difference in the current close and the close ‘n’ periods ago. This is divided by the close ‘n’ periods ago and multiplied by 100.
The first chart below shows the typical ROC indicator. This is a custom indicator and is not available by default on many charting platforms. However, if you are using the MT4 trading platform, there are many versions of the ROC indicator.
Difference between the ROC and the RSI indicator
While the ROC might look similar to the Relative Strength Index (RSI), the calculations are different. The RSI combines both upward and downward price change.
Whereas, the ROC purely looks at the closing price and compares it to the closing price ‘n’ periods ago. Visually though, both the RSI and the ROC might look similar. However, the fact that the RSI oscillates with 70 and 30 levels as the upper and lower bounds makes it unique to the ROC.
The next chart below shows the ROC and the RSI indicators applied to the chart to get an idea of the differences between the two.
An important point to remember is that the ROC indicator can rise in both bullish and bearish markets. This is because momentum rises and falls. Traders should not mistake the ROC to be a directional indicator which is the most common mistake one can make.
ROC Indicator – Conclusion
The Rate of Change indicator is relatively a simple indicator that one can use. You can easily use this indicator by combining with other trend based indicators in order to enter when the trend is the strongest.
In the next part of this article, we will explore some strategies based on a combination of the ROC and the above indicators mentioned.