It is a well recognized phenomenon that security prices surge ahead and retract in a
cyclical wave-like motion. This cyclical action is the result of the changing expectations
as bulls and bears struggle to control prices.
The ROC displays the wave-like motion in an oscillator format by measuring the amount
that prices have changed over a given time period. As prices increase, the ROC rises; as
prices fall, the ROC falls. The greater the change in prices, the greater the change in
the ROC.
The time period used to calculate the ROC may range from 1-day (which results in a
volatile chart showing the daily price change) to 200-days (or longer). The most popular
time periods are the 12- and 25-day ROC for short to intermediate-term trading. These time
periods were popularized by Gerald Appel and Fred Hitschler in their book,
Stock Market Trading Systems.
The 12-day ROC is an excellent short- to intermediate-term overbought/oversold
indicator. The higher the ROC, the more overbought the security; the lower the ROC, the
more likely a rally. However, as with all overbought/over-sold indicators, it is prudent
to wait for the market to begin to correct (i.e., turn up or down) before placing your
trade. A market that appears overbought may remain overbought for some time. In fact,
extremely overbought/oversold readings usually imply a continuation of the current
trend.
The 12-day ROC tends to be very cyclical, oscillating back and forth in a fairly regular
cycle. Often, price changes can be anticipated by studying the previous cycles of the ROC
and relating the previous cycles to the current market.
