Rate of Change

The rate of change indicator is an oscillating indicator that moves back and forth across a zero line. It is based on a calculation that tells you how far the price has moved from a previous point in time. You can determine how far back the calculation goes when you set the parameters for this indicator on your chart.

The theory behind the rate of change indicator is that price can move only so far in one direction before it has to stop and catch its breath. Now, it can catch its breath in one of two ways. It can move back to its original position or it can wait while past price data catches up. Either way, this action is illustrated on the rate of change indicator. When the price begins to make a large move, either up or down, the rate-of-change line will begin to pull away from the central zero line. Then as price movement takes a break, the rate-of-change line moves back toward the zero line.

To put this into context, if you see the rate-of-change line at either a high or a low extreme, you know the major price movement has already happened, and you may want to wait to enter your trade. If you see the line beginning to move away from the zero line or turning around from one extreme and beginning to move in the opposite direction—as it was in both late November and early February on the General Electric (GE) chart—you may want to consider entering your trade.

Now that you're finished reading the text version of this tutorial, watch the video.

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