Key Takeaways🔑
| →The ROC indicator measures percentage changes in the price over a specified period. |
| →ROC is a versatile tool that can help detect divergences, oversold and overbought areas, and trend changes. |
| →Although useful, ROC has its limitations, including sensitivity to whipsaws and equal weightage to recent and old prices. |
Contents
About the Rate of Change indicator
The technical indicator which is called the Rate of Change (ROC indicator) measures the change in the price in percentages. This change is being monitored from a determined number of periods in the past up to the present price. The indicator oscillates around 0 value. It enters the upper positive area when the change in the price has an upward direction. It moves into the lower negative zone when the change is to the downside.
Thanks to the ROC indicator we can detect divergences, local oversold and overbought areas, and centerline crossovers.
Setting up the ROC indicator
When you have your platform opened for a particular asset with a Japanese candlesticks chart typeset, you will see the indicators feature icon in the down left corner. After you click on it the list of indicators will appear. Find the Rate of Change indicator and attach it to your chart. It will be displayed below your price chart.
What can you read from the ROC indicator on the Olymp Trade platform?
The indicator oscillates around 0 value, but it can go unlimitedly high as it shows the change in the price which can evolve infinitely in time.
When the ROC is rising, it usually means there is an uptrend. Be careful, however, because this indicator measures the change only from the specified point in the past.
The same is for the falling ROC. It normally confirms the downtrend, but not always.
Generally, when the ROC is situated above the 0 lines there is a bullish bias.
When the ROC is below 0, normally there is a bearish bias.
When the ROC oscillates close to 0, it means the consolidation on the market. In such a case it is recommended to observe the overall price trend. The ROC does not say a lot more than that there is indeed a consolidation. It is used as information about a possible change in the direction of the trend rather than as a trend change signal.
There is a possibility to use the Rate of Change indicator to give signals of upcoming trend change when you look for places of divergence. Divergence happens when the direction of the price on the chart and the direction of the ROC indicator is not in harmony. For instance, there is a divergence when the asset’s price rising during a certain period of time whilst the ROC is gradually falling. This is a signal that the trend will most probably reverse and start downward. Remember, the divergence can last a long time, so it does not mean you should jump into the trade right away.
A trader can spot the oversold and overbought areas with the ROC but there are no fixed boundaries. It is different for each asset so to determine these levels, it is important to view past readings of the ROC and find the extremes.
How to calculate the Rate of Change
The formula used to calculate the ROC is as follows:
(C2 – C1) / C1 * 100
C1 is the closing price n periods before the most recent period.
C2 is the closing price of the most recent period.
The most important thing in this calculation is to determine the value of n that is to how many periods back you wish to compare the recent price. When you choose a small value of n, you will see the ROC reacts very fast to the changes in the price. The reaction will be much slower with the high values of n. On the other hand, high n values give more accurate signals than the small values of n. Short-term investors can decide on a small n value, for example, 9. But the long-term traders would rather set the value of n to 200.
Once you have chosen n value the most suitable for you, find C2. This is the closing price of the most recent period.
Then look for C1 – the closing price n periods before the most recent period.
Use the formula and get the result.
Repeat these steps with every new finished period.
The Rate of Change and the Momentum Indicator
These are two quite similar indicators. The results a trader will receive from reading them are very comparable. The difference is there is an extra line in a Momentum indicator which is a moving average. The formula for calculations is, therefore, a little bit different.
When we are using the ROC we have to divide the difference between the price of the present period and the price n periods earlier by the price n periods before the most recent period. Thanks to this we will receive value in percentages.
With the Momentum indicator usually, you do not do this. The calculation is simply multiplying the difference in the price by 100, or dividing the most recent price by the price n periods earlier and then multiplying the result by 100.
The readings from both indicators are pretty much similar, although the traders have their favorites. They will choose one or the other according to individual preferences.
Pros and Cons of the ROC Indicator😊👎
Pros:
- Ability to identify potential trend reversals through divergence.
- Can provide insights into oversold and overbought market conditions.
- Simple to calculate and use.
Cons:
- Sensitive to short-term price fluctuations, leading to potential whipsaws.
- Places equal weight on recent and old prices, which may not always be optimal.
- May require combination with other indicators for increased reliability.
| ROC Indicator Element | Description |
|---|---|
| Calculation | ROC = [(C2 – C1) / C1] * 100, where C2 is the recent closing price and C1 is the closing price ‘n’ periods ago. |
| Usage | Used to detect price divergences, identify potential oversold/overbought areas, and anticipate possible trend changes. |
Some shortcomings of the Rate of Change indicator
Some technical analysts claim the recent price is more important in predicting a potential future price than the price from n periods ago. Meanwhile, the ROC calculation places equal weights on the last price and the price before n periods.
The ROC is sensitive to whipsaws. This is true that it can help to confirm the price consolidation when it oscillates around the 0 lines. But when there is price consolidation the changes in the price are very small and the indicator is moving towards 0 value. It can give a false trend trade signal.
When you are using the ROC as a divergence indicator, bear in mind that the signals may come too early. Sometimes the ROC already shows a divergence, but the price continues the previous direction for a while longer. Use the divergence to confirm a trade, but do not use it as an entry trade signal.
The last thing I want to tell you is to remember about the Olymp Trade demo account. It is free of charge, thus you trade completely risk-free. This is just an excellent place to try new indicators like the ROC for yourself. See how it looks like, how it behaves, and how you feel about it. Share your comments with us.
Good luck!
ROC Indicator Q&A🔍
-
- Q: What does a rising ROC typically indicate?
A: A rising ROC generally signifies an uptrend. However, remember that ROC only measures changes from a specified point in the past.
-
- Q: What is the significance of the ROC oscillating around 0?
A: When the ROC oscillates around 0, it often indicates market consolidation. This can be a precursor to a possible trend change.
-
- Q: How can divergences with the ROC indicator be useful?
A: Divergences, when the price and ROC are moving in opposite directions, can signal an upcoming trend reversal.
-
- Q: How are oversold and overbought areas determined with the ROC?
A: There are no fixed boundaries, so it’s important to examine past ROC readings to identify these levels.
-
- Q: What is one limitation of the ROC indicator?
A: The ROC gives equal weight to recent and old prices, which some analysts consider a limitation, as recent prices may be more significant in some cases.