Rate of change (ROC) stands
alone as an important indicator used by many technicians interested in
market momentum. It shows the speed at which a variable changes over a
specific period of time, and can give traders a sense of how two
variables change in relation to each other and at what speed. Here we'll
take a look at ROC and how it's used by active traders. (For background
reading, see Divergences, Momentum And Rate Of Change.)
ROC 101 The
speed at which a variable changes over a specific period of time. Rate
of change is often used when speaking about momentum, and it can
generally be expressed as a ratio between a change in one variable
relative to a corresponding change in another. Graphically, the rate of
change is represented by the slope of a line, or horizontal median
called the equilibrium. It is this median that tells us everything we need to know about rate of change.
The normal time frame for ROC measurement is 10 days. The ratio to build the ROC indicator is as follows:
Rate of Change = 100 (Y/Yx)
"Y" represents the most recent closing price,
and Yx represents the closing price a specific number of days ago. So,
if the price of a stock closes higher today than it did 10 days ago,
the ROC value point will be above the equilibrium, thus indicating to
chartists that prices are rising in that particular issue. Conversely,
if the price in today's session closes lower than it did 10 trading days
ago, the value point will be below the equilibrium, indicating that
prices are falling off. It is safe to say that if the ROC is rising, it
gives a short-term bullish signal, and a bearish sign would have the ROC
falling. Chartists pay great attention to the time period in the
calculation of ROC. Long-term views of the market or a specific sector
or stock will use perhaps a 26- to 52-week time period for Yx and a
shorter view would use 10 days to around six months.
Example - Exxon Mobil
Figure 1: Exxon Mobil ROC
Source:Tradestation
As you can see in this chart of Exxon Mobil (NYSE:XOM), the events
of September 11, 2001, saw the ROC fall off dramatically over the five
trading sessions shown on this chart and rallying into the strong market
Sept 24, 2001. You can see that the red line turned up sharply that day
as the price of XOM jumped over $2. You can see that for the most part,
the preceding summer months had Exxon Mobil falling off slightly in
price from a level of about $47 in early June to $41 on Sept 10, and the
ROC indicator traded below the median line for almost the entire
three-month period.
Another important point is the bullish move
at the end of the first week in April, when the stock price jumped from
$38 to between $44 and $45 by the end of the month.
Example - Nortel Networks
Figure 2: Nortel Networks' ROC
Source: Tradestation
The second chart is that of Nortel Networks and shows the
bearish trend from September 2000 through the next 12 months. There were
a number of bullish signals over this same period of time that, for the
most part, would have been acted upon by the short-term traders, but it
is fairly safe to say that long-term investors would have stayed away
from NT during this period of time. The fundamentals of the company
coupled with the bearish indicators saw the "smart money" head for the
sidelines. As you can see by the chart, there was not a strong bullish
sign since the brief tech breakout in April 2001 that lasted just long
enough to tease investors into thinking that the bear market for tech
issues was over.
