What it is and what it shows
The ROC is calculated by taking the difference between the current price and the price a certain number of periods ago, divided by the price a certain number of periods ago. The result is multiplied by 100 to provide a percentage.
Formula:
- ROC = [(Current Price – Price n periods ago) / (Price n periods ago)] * 100
For example, if the current price of a stock is $110 and its price 10 days ago was $100, the ROC would be:
ROC = [(110 – 100) / 100] * 100 = 10%
This indicates that the stock’s price has increased by 10% over the 10-day period.
How to trade it
- Zero Line Crossovers:
- Divergences:
- Overbought/Oversold:
Buy when the ROC crosses above the zero line, indicating potential upward momentum.Sell or go short when the ROC crosses below the zero line, indicating potential downward momentum.Example: If an asset’s ROC moves from -2% to 3%, crossing the zero line, it can be taken as a bullish signal.
Bullish divergence: When the asset’s price makes lower lows, but the ROC makes higher lows.Bearish divergence: When the asset’s price makes higher highs, but the ROC makes lower highs.Example: If an asset’s price forms a new low, but the ROC forms a higher low, it suggests weakening downward momentum.
While the ROC doesn’t have fixed levels for overbought or oversold conditions, traders can establish these based on historical observations of where the ROC typically reverses.Example: If the ROC reaches a level it hasn’t reached in a long time, it might indicate an extreme and a potential price reversal.
Limitations Of The ROC
- Volatility: ROC can be very volatile, especially with volatile assets, leading to potential false signals.
- No Trend Insights: ROC focuses on momentum and doesn’t offer insights into the direction of the longer-term trend.
- Subjectivity: The absence of standardized overbought/oversold levels can make interpretation subjective.
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