This is an excerpt from the soon to be released Liberated Stock Trader book and the accompanying “Academy Pro Training Course”

The rate of change is very similar to the Momentum indicator mentioned in the previous section, with one important difference, instead of a subtracting the latest price from the price X periods before it divides it.  This is an important difference that improves the indicator.

Rate of Change = 100 (C / C^X)

The results of ROC are similar but slightly better than that of Momentum as it handles large price swings better.  As in the previous section, follow the numbered steps in the following Chart to understand how ROC can tell the story of future price movement.

Freestockcharts.com  chart courtesy of Worden Brothers, Inc.

Now this is a busy chart.

1. Using a trend line we can see that ROC breaks its downtrend at the end of November 2008.  This is a useful way of using Oscillators, plotting trend lines on them.  As oscillators are leading indicators using a trend line will show us when a trend change happens before it is reflected in price.
2. The price then follows by moving up from 18.90 to 24.30 a 23% gain.
3. Here we see a false signal, this shows us that no indicator is perfect.  Always remember the price move is the most important, Oscillators can help us to improve our chances of guessing correctly.  However this time it fails.
4. ROC indicates a positive divergence, yet price hits resistance at 24.30 and then plummets south.
5. ROC now corrects itself and 2 days before the actual severe price drop ROC shoots downwards, this is a warning sign top exit.
6. Here again ROC shows a negative divergence.
7. Price again hits resistance in June at 21.50.  ROC’s divergence was correct and the stock drops.
8. ROC Surges upwards in August and although price retraces in September ROC powers on showing a positive divergence.
9. The first 2 weeks in October the price surges again.
10. ROC shows another negative divergence with the price trend.
11. No new price high
12. Price falls, again predicted by ROC.

You are now familiar with positive and negative divergences, but also realize that price is the most important indicator and that Oscillators can be wrong.  Wait for the indicator to scream, if it says nothing move on.

Learn Stock Market Trading and Investing with FREE Education and Training on Stock Screening, Stock Charts, Candlesticks, Technical Analysis & Fundamental Analysis and Stock Chart Indicators, Trading Academy Membership is free register here.

Other Chapter excerpts from the Liberated Stock Trader Book & Training Course are here :

Chapter 1 – Essential Stock Market Knowledge – Fundamentals

Chapter 2 – Why do Booms and Busts Occur?

Chapter 3 – Stock Market Cycles – Business & Economic Cycles – Kondratieff to Kuznets

Chapter 4 – Is the Company in great shape – P/E Ratio

Chapter 5 – How to find the best stocks

Chapter 6 – Japanese Candlesticks – Bullish Reversal Patterns

Chapter 7 – How to draw trend lines

Chapter 8 – ROC Rate of Change Indicator