How Can The ROC Indicator Be Useful For Your Trading?

The ROC indicator (rate of change) is simply an oscillator that is mainly used for determining the momentum of a stock.

This is a simple technical indicator and one that is very easy to understand. Because of that and because of it's usefulness, it is one of the favorites among many technical investors.

The Formula

You may be thinking, "Math. Awwww, how dry and boring." No worries however, I will try to spruce it up for you as much as I can.

So, here's the formula:

Y represents the most recent closing price. Yx represents the closing price x number of days ago. So, the most recent closing price divided by the closing price a specific number of days ago times one hundred gives you the ROC indicator.

The Median Crossover Signal

So now we know that the ROC indicator takes the difference between the current stock price and the price ten days ago. And, as with every oscillator, you can customize it to change the number of days.

But how does this help us?

This tells us that when the current price is higher than the past price, the stock has upward momentum. This is shown on the indicator, by the line being above the zero line (the median line).

As I'm sure you have concluded, that the opposite, a downward momentum stock has a line that is below the median.

You can use the median line as an indicator in itself. Such as when it crosses above, it is a bullish indicator and when it crosses below it is a bearish indicator. However, this can give many false signals.

But don't worry, that's not the only way you can use this indicator. There is another way that gives more reliable signals. That way is by...

Drawing Overbought And Oversold Levels

Sadly, the ROC indicator does not have specific overbought and oversold levels already plotted. However, you really don't need them.

But some investors have taken it upon themselves to draw these levels themselves and use them for they're trading strategy.

To do this, you simply have to annotate the chart. Many stock charts have an option for this. If there is no option, you will have to use a photo editing program.

Once you are ready, place one horizontal line near the bottom of the chart and one near the top.

I wish I could tell you exactly where to put them. But with this step, you will just have to eyeball it.

I can give a little advice though...

The top line should cross over at least two thirds of the peaks. And the bottom line should cross over at least two thirds of the troughs.

So, now you have drawn your own overbought and oversold levels. Congratulations.

Using The Levels For Trading Strategies

With these, you now open yourself up to a few other strategies that you couldn't use before.

With each strategy you will want to stay away from the extremes.

Ill use the overbought signal in my examples. But, the oversold signal is the same except vise-versa.

When the price goes above the overbought signal, you want to sell or go short. When it comes back down, you want to do the same. Be careful because sometimes it goes right back up. In this case it was a false signal and you will most likely want to reverse your position.

That is the strategy that has been found useful most of the time and has become standard practice.

Use The Basics

These two strategies which I have explained to use are not all the known ways of trading with the ROC indicator. However, they are the most basic and the two most common.

After you master these, you may want to check out how to use this indicator for a more advanced technique, divergences.

Remember, one oscillator never gives you enough information to make an informed decision with a stock. You should have at least a few open at all times.