This study monitors market momentum. It calculates the market?s rate of change relative to previous trading intervals. At the peaks, the indicator suggests a market that is overbought. Valleys or troughs indicate an oversold market condition. When the indicator begins to move back toward the zero line, this may indicate that the current trend is losing momentum.

Some market technicians use a very simplified approach for the rate of change study. It issues buy and sell signals based upon the midpoint or zero line. You sell when the rate of change line crosses from above to below. You buy when the indicator crosses from below to above. This assumes that an oversold or overbought market condition precedes the crossover.

In most instances, it is best to use this indicator as a precursor to change in market direction. One approach is to establish extreme zones for the study, much like the RSI or Stochastic. Also, the indicator is similar to an oscillator with regard to the market accelerating or decelerating. However, a good technical analyst must learn to tolerate the study in extreme bull and bear markets. It can generate many false signals under those market conditions.

The ROC can be used as an excellent short-term to intermediate-term overbought/oversold indicator. Higher ROC values indicate an overbought contract. Lower ROC values indicate a possible rally. A word of caution must be issued when using overbought/oversold indicators: it is wise to wait for the market to correct before placing a trade. In spite of all expectations, markets that appear overbought may remain overbought for some time, and extreme overbought/oversold situations often suggest a continuation of the current trend.

This indicator is described in more details in the Steve Achelis' book "Technical Analysis from A to Z".

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