Price rate of change, or ROC, is a technical indicator used to signal the momentum of a price’s current trajectory. Price rate of change comes from a class of technical indicators known as momentum oscillators, which are employed in a variety of ways in momentum or trend investing.
The formula for calculating the price rate of change is [(today’s closing price – the closing price n days ago)/the closing price n days ago] x 100.
Price Rate of Change Example
Suppose that the closing price today was $20 and the closing price 5 days ago was $16. The the price rate of change would be [(20-16)/16]x100 or 25.
Price Rate of Change as an Indicator
The price rate of change is displayed as a separate indicator below the standard price chart. It is displayed as a graph that oscillates between 100 and -100, with each closing price acting as a data point on the graph.
Price Rate of Change in Trading
Price rate of change is used as a momentum indicator measuring the current strength of a price trend. This means that the price rate of change is used as a complement to traditional price analysis, providing a contrasting perspective on the traditional price chart.
For example, a positive price trend with a high price rate of change signals a strong likelihood of continued price increases, while a positive price trend with a low and sloping price rate of change graph indicates a likely upcoming reversal in the trend as it runs out of momentum.
The price rate of change can also be used separately as an indicator of a security being overbought or oversold, with values greater than 30 being seen as an indicator that the security is overbought and values lower than negative 30 indicating that the security is oversold.
Trading with the Price Rate of Change
Momentum investing is a very popular technical analysis approach used by contemporary day traders due to its accessibility and overall success rate.
Even many top hedge funds and investment firms use momentum-based strategies, as markets have tended to move synchronously over the last few decades, particularly in advanced markets with abundant quantitative easing.
The idea behind momentum investing is to identify strong price trends in their early stages, and then quickly enter these trends to capture a short yet substantial change in price.
This makes momentum investing particularly attractive to day traders, as it offers a strategy that works in both directions and with which they can quickly enter and exit positions.
The challenge in momentum investing is, of course, differentiating the beginning of a strong trend from the general rise and fall of regular market noise.
Enter a trade too early, and the day trader risks languishing or taking a loss as the small price change quickly reverses. Enter a trade too late, and the day trader risks missing the bulk of the price change and entering the trade just as it begins its long reversal.
That is why momentum oscillators, such as the price rate of change, are so essential for measuring the momentum of a price trend from a variety of perspectives.
When momentum trading, price rate of change should be combined with a number of other trend indicators to ensure that the recent price change has all the right signs for a strong upcoming trend.
Day traders who are interested in momentum trading are encouraged to practice with a variety of indicators until they have a chart setup and familiarity that allows them to consistently identify strong trends to trade.
Final Thoughts
The price rate of change technical indicator is one of a number of momentum oscillators that are used primarily in momentum or trend investing.
Day traders are encouraged to use a variety of momentum oscillators, including the price rate of change, until they feel that they have an intuitive grasp for identifying strong price trends to trade.
Momentum trading can lead to many false positives, and those day traders who stand out from the rest manage to develop a certain ‘sixth sense’ about when a price trend is about to take off and when it is merely the background noise of the market.