Learn the ROC trading strategy yet another momentum-based stock strategy but with a twist. ROC trading puts into practice two concepts: studying the strength of the trend and possible momentum shifts. By the end of this stock trading guide, you’ll learn how to trade with ROC indicator as a stand-alone system.
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It’s important to be able to react very quickly to the constant rapid changes in stock prices. However, it’s also advised to have an objective view of where the stock market is going. This objective view can come from something that is referred to as the Rate of Change (ROC).
As you know, the real market environment is quite dynamic and you always have to adapt to the ever-changing market conditions. This is the reason why we use the ROC trading strategy to provide us with better buy and sell signals as well as exit points.
The ROC is a short abbreviation that stands for Rate of Change (ROC) which is a technical indicator that is part of the momentum-based indicator family. The ROC oscillator measures the percentage change in the current price and the price N periods ago.
In other words, the Rate of Change tells us how fast the current price is moving compared to yesterday or versus last week, or versus last month, etc.
You can simply view the ROC indicator as a velocity indicator.
The concepts behind the Rate of Change (ROC) primarily measures two things:
- When shifts in momentum occur.
- Trend strength and weakness.
If you combine these two principles, you have the potential to find great reversal trading opportunities.
The ROC indicator oscillates above and below a zero-level midpoint. Positive ROC readings typically confirm a bullish trend while negative ROC readings typically confirm a bearish trend.
One important point to understand is that theoretically, a stock can fall only 100%. In this regard, the lower bound of the ROC is -100.
A $10 stock listed on the New York Stock Exchange (NYSE) can become $0 at max, it can’t go negative. However, the same $10 stock can go to $50, or $100, or $1,000.
Theoretically, there is no upper limit for how much a stock’s value can appreciate.
As a result, there is no upper limit to the ROC.
To sum up everything:
- Lower ROC bound = -100 percent.
- Upper ROC bound = infinity.
We’re going to show you how to calculate the ROC and how to plot the ROC indicator on the price chart.
The ROC indicator formula is revealed below:
ROC = [(Closing Price – Closing price N periods ago)/ Closing price N periods ago] x100
- Closing price = closing price of the last day or the most recent period.
- Closing price N periods ago = The N value is how many periods back the current price is compared to.
The default number of periods for which we calculate the ROC is 9-periods. The 9-periods ROC indicator is more suited for short-term trading. For long-term trading, stock traders need to choose a bigger period like 50,100 or even 200 periods in the case of really long-term investors.
The multiplier 100 at the end of the price Rate of Change indicator formula is used to transform the result in percentage terms.
Now that you know what is the ROC formula, let’s see how to trade with ROC indicator.
Below, we’re going to reveal what are the most popular ways traders use the ROC in the stock market.
In short, the ROC indicator moves in tandem with the price. If the stock price is rising compared to N-periods before then the ROC will be positive. Conversely, if the stock price is falling compared to N-periods before then the ROC will be negative.
Now, on the same TESLA stock chart above, you can notice that when the stock price is in consolidation mode, the ROC tends to gravitate towards the midpoint aka the zero levels.
The ROC oscillator falls (rise) in tandem with the stock price. At the same time, the rate of falling (rising) in the stock will become more depressed (strong) as the stock price falls (rises) more speedily.
Now, as soon as the rate of fall (rate of change) decreases, the ROC will bottom out and the negative value of the ROC reduces. As soon as the stock is at the bottom, the ROC value of the stock will start rising as the stock value is not falling anymore.
Now as soon as the stock price goes up a little bit, the ROC value should turn positive depending on how far back (how many periods back) the ROC calculation goes. As the speed of the ROC increases, the stock price will also move higher more rapidly.
And, towards the pick of the stock, the ROC oscillator will again fall as the rate of price changes will slow down. In a nutshell, this is how you can interpret the ROC behavior.
Here is a short summary of how to trade with ROC indicator for beginners:
- A sharp surge in the ROC indicates that the stock prices are advancing more rapidly.
- A steep decline in the ROC indicates that the stock prices are declining more rapidly.
- When the ROC hovers above and below the zero line, it indicates that the price is consolidating.
- Crossover of the ROC zero line can indicate a shift in the current trend.
Note* Please be aware that the crossover strategy can be a little bit riskier as the ROC indicator is prone to whipsaws (see chart below).
The ROC indicator can also give us overbought and oversold signals. However, without a reliable ROC trading strategy, the ROC overbought and oversold signals are not as accurate as the RSI indicator or the stochastic indicator signals.
In the following headings, we’re going to show you a proven method to trade ROC overbought and oversold signals.
Another less common application of the RSI indicator is to trade divergence signals.
The ROC divergence signals happen when the stock price moves in one direction but the ROC oscillator moves in the opposite direction.
See the ROKU stock chart below:
You might be wondering why you should use the ROC, and not the RSI oscillator or Williams’s %R indicator or other oscillators. While these indicators are not mutually exclusive, it is important to understand what makes each unique.
First, the ROC is a leading oscillator that can be used to spot stocks with high momentum, which normally in the short term will outperform the market. In other words, ROC stock selection can help you buy quality stocks with the hope of achieving a positive return.
Some stock screeners come with the ability to track ROC stocks and set up alerts for Rate of Change signals.
If you’re interested to learn more on this topic, check out our stock guide Best Practices to Pick Winning Stocks.
While we have your attention, you should check out our free stock trading class by clicking on the banner below and learn to trade like a pro today.
To sum everything up:
If we break down the trend and study the way the trend is moving, we might notice that the rate of change or the speed at which the trend is moving is changing. The main idea is to use the ROC indicator to potentially detect areas where the market is starting to slow down or speed up
The rate of change is going to potentially tell us how strong buyers and the sellers that dominate the market are.
Let’s see how to trade with the ROC indicator in combination with other technical indicators.
If you want to get deeper into how to combine trading indicators like a pro check our guide here: Best Combination of Technical Indicators.
This ROC trading strategy will help anyone learn how to trade with the Rate of Change indicator to forecast future stock price momentum shifts.
We don’t want to discriminate against any particular trading style.
So, in an effort to make everyone happy we’re going to outline two approaches:
- ROC trading strategy for short-term traders (scalpers and day traders).
- ROC trading for long-term stock investing.
Let’s first give the long-term stock investor some food for thought.
Long Term Stock Investing with ROC Trading
It’s not a secret that momentum-based oscillators are a day trader’s best friend. However, the ROC indicator makes a great tool for long-term stock investing.
When you trade on the long-term stock chart, the shift in the market sentiment will be visible with a delay. So, inevitably you’ll be late for the party.
The twist to get around this trap is to analyze the trend in multiple timeframes.
There are 250 trading days within a year, which can be further broken down into:
- 125 trading days per half-year.
- 63 trading days per quarter.
- And, 21 trading days per month.
Naturally, a trend reversal would first occur and be visible on the lower timeframes and slowly roll out to the other timeframes.
Now, here is how to spot an early shift in the market trend.
If the 250-period ROC and the 125-periods ROC are both positive, then the long-term trend is bullish. At the same time, you’ll notice that the shortest period (ROC-21) will produce many whipsaws due to the natural ebb and flow of the market.
The rule we’re going to use two-time frames to confirm a shift in the trend direction.
In this case, we want 21-period ROC and 63-periods ROC to both turn negative to confirm an early shift to the downside. Once they hold below the zero levels the 125 and 250 periods ROC should also turn negative to really confirm a change in the trend.
See the FB stock chart example below:
Short-Term ROC Trading
To determine the overall intraday trend, we’re also going to plot the 40-period moving average. When the slope of the moving average is up we know the general stock trend is up.
See the Tesla stock chart below:
We can notice that as Tesla’s stock price was moving higher, the ROC was slightly coming below the zero levels. In an uptrend, you can find that when the ROC is coming out of the negative territory and moves above the zero level, the Tesla price was bottoming, providing us with great buying opportunities.
The 20-period moving average is there to keep you out of big troubles and possible big losses.
Here is another application of the 20-periods MA in combination with the ROC indicator.
When the moving average turns flat, it indicates that the market is in consolidation mode and inevitably the ROC will gravitate towards the zero levels (see the chart below).
This means the ROC will cross back and forth at the zero levels resulting in many false signals.
In this market scenario, it’s best to stay out and better find another stock that it’s in a clear trend.
In summary, ROC trading is all about detecting momentum shifts in the price of a stock. Like all technical indicators, it’s a good idea to complement the ROC indicator with other tools. It’s important to keep in mind that the ROC indicator has its own limitation and that’s the reason why the ROC trading strategy presented through this guide combines other trading methods or technical indicators.
Here is a quick summary of what you’ve learned today:
- ROC is telling us how fast the price is moving compared to previous periods.
- ROC upper band is unlimited while the lower band is limited to -100.
- ROC rises and falls with the price.
- Stock prices are consolidating when the ROC hovers near the zero level.
- ROC indicator is good for stock selection.
- For long-term investing analyze the trend in multiple timeframes.
Thank you for reading!
Feel free to leave any comments below, we do read them all and will respond.
We also recommend learning about the Relative Strength Index (RSI).
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