Stocks are one of the most vital financial instruments in the world today. Here's a guide to provide a basic understanding of one ...
Read this guide to find out what Rate of Change (ROC) is, why it’s important to measure it, and how the rate helps traders determine possible price changes.
Rate of Change (ROC) describes the percentage change in a variable over a specified period. The term is often linked with momentum and it is denoted by delta, a Greek letter. In certain cases, ROC is the ratio between the change in a variable in relation to the disparity in another variable
A line’s slope can also be used to represent ROC graphically. Mathematically, an asset’s current price is divided by the asset’s value from an earlier period. The mathematical representation is given as:
ROC= (current value/previous value −1)∗100
It is also worth noting that the momentum indicator a good number of traders rely on for analysis determines the momentum using ROC. And a higher number for the ROC is an indication of faster speed. Coupled with that, the ROC is applicable to a wide range of data series. It is applicable to mutual funds, ETFs, indices, and so much more.
It is important to measure ROC for several reasons. Notable among this is your ability to track a security’s momentum, as well as, other trends. An instance can be seen in an asset with a positive ROC (high momentum security), which could spike in price in the near term. Hence, this is taken as a buy signal.
The reverse is the case in security that trades below its moving average. The asset could also have low momentum or a negative ROC. Here, the security could potentially depreciate in value, hence, it is used as a selling signal.
Another advantage of using ROC is to gain an idea of whether the market is in a bubble. For instance, a sharp spike in the ROC of an asset with a broad market, in the short term, could signal an unsustainable market despite the asset’s positive ROC. Also, if the ROC of the asset is above 50%, it could signal a bubble. That being the case, ROC can be used on its own as a trading strategy. There are cases where the ROC is paired with the moving average and used to trade.
There is a close relationship between ROC and price. First off, ROC serves a measure of the change in an asset’s price over time. It can also be called a price range of change (ROC). In addition, the ROC is ascertained by considering the asset’s price at a certain time (B) subtracted from the security’s price at another time (A). The answer is then divided by A.
This relationship is mathematically represented as:
Price ROC= B−A/A ×100
These values represent: B=the price at the current time; A=the price at the previous time.
The formula above is useful to help traders determine how fast the price changes in relation to each other. It can be used to analyze the relationship between the ROC in the price of an asset in relation to a minor change in the price of its underlying asset.