Rate of Change Forex Trading Strategy
One of the most popular technical trading indicators among more experienced forex traders is the momentum oscillator. Traders can forecast the potential price changes in the market before they occur by using the leading oscillating indicator. One great representation of the momentum oscillator is the rate of change (ROC) indicator that measures the changing speed of the price within a defined timeframe.
The indicator calculates the change of percentage between the current price and a few periods back registered as “n.” It forms an oscillator that fluctuates as the rate of change above and below the zero lines. Traders also use the ROC to detect divergences, confirm price moves, centerline crossovers, and as a guide to determine overbought and oversold situations.
However, it is essential to note that trading with the oscillator solely on its own will give you unreliable and, most likely false signals. If you want more reliability and signals that you can trust, use the momentum oscillator with other technical trading indicators.
The oscillator setting used in technical analysis of price movements in the market is against midpoint zero-level. When the ROC rises above zero, it is a confirmation of an uptrend. If it falls below zero, that is an indication of a downtrend. If the ROC hovers near the zero point, it is an indication that the price is consolidating.
It is very crucial for traders using the ROC oscillator to watch the price trend keenly because the ROC provides minimal insights except for consolidation confirmation.
- Picking the value of the “n” in the ROC calculation is the first primary step. The value chosen varies from one trader to the next, with short-term traders preferring a small value that could be as low as 9, while long-term traders prefer larger values that could go up to 200.
- The “n” value represents the many periods ago compared with the current price. While smaller “n” values react faster to market price changes, they also provide a more significant number of false signals.
- On the other hand, larger “n” values react much more slowly, but they give more meaningful and trustworthy signals. The steps to calculating ROC are as follows.
- Make a selection of the n value, which can be any number such as 12, 25, or 200. If you are a short-term forex trader, choose a small value and a larger one if you are a long-term investor.
- Track down the latest and updated closing price
- Track down the n periods ago for the close price of that timeframe
- Attach steps two and three prices into the formula
- With the close of each period, make a new calculation of the ROC value
ROC = [(P – PN) / PN] x 100
P = Closing Price
N = Number of periods ago
Rate of Change (ROC) Pros and Cons
- It is ideal for currency trending market situations
- When used in conjunction with trading indicators, it gains more strength at identifying strong momentum
- It helps to identify an overbought and oversold situation on a moving price chart
- It helps to detect divergences
- It is not the best indicator to use to identify cycle turns as it can give many false signals
- If you are looking for the best price action analysis, this indicator tool will not provide you with all the necessary data needed unless you use it in conjunction with other technical indicator tools
- It is not the most straightforward indicator to use, especially for new forex traders
- If not used correctly, it can produce several whipsaws
- It gives equal weight to the price of several periods ago and the current price, which should not be the case. Future price movement should depend more on the current price than on a few periods ago.
Wrapping it up
Momentum oscillators are best suited for flat trends or during trading ranges. However, they also come in handy when it comes to identifying the direction an underlying trend takes, like the rate of change trading tool.
Moreover, it measures the price changing speed with an upward surge and downward plunge that is good enough to provide traders with enough knowledge on the action to take. Like many other technical trading indicators, the rate of change is not reliable on its own, but it is more robust when used in conjunction with other technical analysis tools.