The Rate of Change indicator (ROC) is a way of showing how rapidly the price of a particular share (or other financial instrument) is moving.
The theory is that if a price is rising (or falling) very quickly there will soon come a time when it is thought to be overbought (or oversold). When this occurs the price may still continue to rise (or fall), but not as rapidly as it was before.
This oscillator always has a value between 0 and 10 and is calculated from the average of all price rises in a given period divided by the average of all price falls in the same period. Again the choice of period is arbitrary and dependent on your position in the markets.
The rate of change indicator is :
| ROC = 100 - 100/(1+X) |
| where X = (average of price rises) / (average of price falls) |
The neutral position of this oscillator is at 50; if it rises above 50, the instrument is becoming overbought, if it falls below it is becoming oversold. Critical levels exist at 75 and 25. An ROC above or below these levels indicates the instrument is very overbought or very oversold, and a price reversal is imminent.
The charts below show the share price of Guardian Royal Exchange (top) and the ROC oscillator (bottom). Note how the Sell and Buy prompts at ROCs of 75 and 25 respectively would have resulted in handsome profits.
Click here for the full size graph.
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