Indicator Rate of Change: measure the level of the market optimism

The task of measuring the speed of a price appeared simultaneously with the financial market. The trader at any time needs to understand which way the seller/buyer balance is shifting and whether he/she will have time to join this movement.

The practice has shown: the more complex the calculations of a technical tool that tries to assess the speed of a market reaction, the less confidence is caused by its result.

Simple, even primitive calculations are needed for this purpose, without averaging, rounding, complex filters and other correction mechanisms. The elementary calculation of the Rate of Change indicator guarantees sufficient accuracy and allows you to obtain advanced signals.

 

Rate of Change Indicator: Logic and purpose

The speed of the market is the assessment of the price dynamics inside the selected timeframes. The growth of the positive «expectations» causes the indicator’s line to move upwards − there is optimism on market and in the near future, it is necessary to expect the beginning or strengthening of the upward trend.

The loss of the optimism about the trading asset unfolds the indicator downwards − the activity of participants is reduced and a period of consolidation can be expected.

By tilting the indicator graph, you can determine whether the current movement is accelerating or slowing down.

We remind you that the accuracy of the calculation depends on the scale of data. The minimum timeframe in the standard Forex terminal is M1, but if you have the opportunity to settle on tick quotes with a period of less than 1 minute, the result will be correct.

 

Rate of Change Indicator: Calculation procedure

Indicator Rate of Change is calculated as the difference between the current closing price and the price at which the market closed several periods ago (in absolute values or in percentages).

Calculation formula:

where

• PriceClose (i) −is the closing price of the current bar;
• PriceClose (i-n) − closing price n bars back.

This is the so-called «normal Rate of Change», the source of the formula is the famous book by John J. Murphy «Technical Analysis of Financial Markets…».

In modern practice, the notion of the «normalized Rate of Change» is used, which calculates the average value:

The interface of Forex Tester software uses a version calculated by Murphy’s formula, but the essence of indicator is not changed.

The dynamics of the ROC and Momentum indicators is the same, but for the Rate of Change the zero line is considered to be the balance line, and for Momentum − the level is 100.

Please note that the ROC indicator reacts twice to the same price change. First, there is a reaction to the current change, and then the indicator changes again − at a time when the «old data» is already leaving the calculation interval.

Usually, this problem is solved by calculating the «smoothed speed»: first, EMA is calculated from the closing prices (usually with a shorter period than is planned for calculating ROC) and the Rate of Change calculation is performed on this data.

Rate of Change Indicator: Parameters and control

The Rate of Change – is a typical oscillator, located in an additional window below the price chart.

In addition to setting the color, the indicator contains only two parameters − period and price type for the calculation. The balance line is traditionally set to the «0» level, and symmetric levels higher/lower as the boundaries of the flat range or the boundaries of overbought/oversold zones can also be used.

Standard version of the indicator Rate of Change

The positive acceleration of price is reflected above the balance line, the negative (slowing down) − is lower.

The requirements for the parameters − are standard. The shorter the calculation period (short ROC), the more sensitive the indicator line will be, and accordingly, more false signals will appear. The longer the period (long ROC), the higher the confidence in the signals, but then the delay effect is more notable, especially during the speculative market.

A long and short period in the Rate of Change

The effectiveness of Rate of Change is highly dependent on the timeframe − in small periods there are always a lot of random factors affecting the price. But on the periods from H4 and higher, it is easier to monitor the actions of the large market participants.

Let’s look at it in detail.

 

Trading signals of the ROC indicator

As for the Rate of Change signals, there are no tricky secrets − everything is traditional for oscillators, which are calculated only on the basis of price, without taking into account trading volumes.

• Trading on the breakdown of the balance line

The zero-line crossing from bottom to top − is a buy signal, from the top down − the sell signal. For the reliability of entrance, it is recommended to open a deal in case of breakdown of the boundaries of flat zone established at levels of 10-20% above/below the balance line.

• Reversal from critical Zones

If the ROC line is extremely high and then turns down, this indicates that the trend continues, but market activity is declining, the bullish trend is slowing down. If the values of ROC form extremely low values (depressions) and start to grow − sellers are weakened, but the bearish trend is still preserved.

In such situations, it is useful to establish the boundaries of overbought/oversold zones, but if the absolute values of indicator are used, then such levels must be periodically adjusted. We open a deal when the indicator line leaves the critical zone.

• Control of the flat zone

Quite often the price continues to update the extremes, but at the same time, ROC moves in the zone of zero line.

This is a very dangerous time to enter against the main trend, although you can try to trade for a retreat from the border of the flat, checking that the current trend is maintained. If there are previously opened positions, it is strongly recommended (at least partially!!) to lock in profits and move Stop Loss closer to the current price.

Classical signals of ROC indicator

• Divergence/convergence

Bullish divergence: if the higher max price is not supported by a higher ROC value.

Similarly, a bearish convergence appears if the lower min price is not confirmed by a lower value on the ROC line.

Trading schemes for divergence and flat on ROC

• Application in the trade strategies

The Rate of Change is not used as an independent trading system, but its application can be beneficial in complex strategies with mandatory confirmation of the signals by trend indicators.

The main thing is to follow the usual principle for the oscillator of determining the priority of bulls (above balance line) or bears (below zero line).

We remind you that on trading assets with a problematic volatility and at the moments of speculation, the accuracy of the Rate of Change signals is sharply reduced. We use it only in a stable market!

Rate of Change as an oscillator

As an additional filter, you can use the Moving Average on the Rate of Change data − this increases the accuracy of entry in the trend reversal.

ROC+MA: input at the intersection of the lines

Moving average enthusiasts use the classical trend logic: in one window it is possible to build two ROC lines − fast and slow. The signal to buy will be displayed as the intersection of a faster line with its slow «counterpart» from bottom up. And, conversely, when crossing from top to bottom, you can sell.

ROC: input at the intersection of moving averages

There are no special advantages of the Rate of Change indicator, most often it is used in trading terminals on tick data to search for divergences.

What this means is: the use of the ROC instead of the traditional Stochastic or RSI should be tested thoroughly (see Using Indicators).

 

Conclusion: Indicator Rate of Change

The foreground properties of Rate of Change are clearly exaggerated. According to the classical theory of the market, the final phase of the uptrend is always accompanied by a rapid price increase («the participants still believe in continuation of growth»), respectively, the completion of the downward trend is characterized by a sharp drop («the participants are already trying to exit the market»).

In the stock market or commodity futures all this is happening, but in the Forex market, it is not worth hoping for such reasoning.

At any time, the price may be affected by political or other force majeure factors and the market unfolds without such a final throw of the price.

ROC simply does not have time to react and gives out unintelligible signals. For those brave traders who still decide to use this classic oscillator, we strongly recommend using a smoothed version of the indicator.