The Price Rate of Change study is first calculated by dividing the price change over the last ‘n’ periods by the closing price of the instrument ‘n’ periods ago. The result is the percentage by which the price has changed over the last ‘n’ periods. If the share prices increase in this period, the ROC will be a positive number; and a negative number with decreased share prices.
Properties
Period. The number of bars in a chart. If the chart displays daily data, then period denotes days; in weekly charts, the period will stand for weeks, and so on. The application uses a default of 10.
Aspect: The Symbol field on which the study will be calculated. Field is set to “Default”, which, when viewing a chart for a specific symbol, is the same as “Close”.
Interpretation
This study monitors market momentum. It calculates the market’s rate of change relative to previous trading intervals. At the peaks, the study suggests a market that is overbought. Valleys or troughs indicate an oversold market condition. When the study begins to move back toward the zero line, this may indicate that the current trend is losing momentum.
Some market technicians use a very simplified approach for the rate of change study. It issues buy and sell signals based upon the midpoint or zero line. You sell when the rate of change line crosses from above to below. You buy when the study crosses from below to above. This assumes that an oversold or overbought market condition precedes the crossover.
In most instances, it is best to use this study as a precursor to change in market direction. One approach is to establish extreme zones for the study, much like the RSI or Stochastic. Also, the study is similar to an oscillator with regard to the market accelerating or decelerating. However, a good technical analyst must learn to tolerate the study in extreme bull and bear markets. It can generate many false signals under those market conditions.
The ROC can be used as an excellent short-term to intermediate-term overbought/oversold study. Higher ROC values indicate an overbought contract. Lower ROC values indicate a possible rally. A word of caution must be issued when using overbought/oversold srudies: it is wise to wait for the market to correct before placing a trade. In spite of all expectations, markets that appear overbought may remain overbought for some time, and extreme overbought/oversold situations often suggest a continuation of the current trend.
Literature
Kaufman, Perry J. The New Commodity Trading System and Methods. 1987.
Murphy, John J. The Visual Investor. New York, NY: John Wiley & Sons, Inc. 1996.
Murphy, John J. Technical Analysis of the Futures Markets. New York Institute of Finance. Englewood Cliffs, NJ. 1986.
Le Beau C., Lucas D. W. Computer Analysis of the Futures Market. 1992.
Colby, Robert F., Myers, Thomas A. The Encyclopedia of Technical Market Indicators. Dow Jones – Irwin. Homewood, IL. 1988.
Pring, Martin J. On Market Momentum. 1993.
Babcock, Bruce. The Dow Jones – Irwing Guide to Trading Systems. 1989.
Content Source: FutureSource
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