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Smoothed Rate of Change

Fiala Petr
Published: 18.2.2012 | Last modification: 23.2.2012 10:28  | Comments: none
Smoothed Rate of Change indicator

I found this indicator in the book by Dr. Alexander Elder called "Trading for Living."  The original inventor of the indicator is Fred G. Schutzmann. - - The indicator is unbounded, and it oscillates around zero. Instead of the actual price, the calculation uses the exponential moving average, to which the rate of change principle is applied. Calculation:

_SECTION_BEGIN("Smoothed ROC");

P1= 4; P2= 14; EMA_CLOSE = EMA(CLOSE,P1);

SMOOTHEDROC=( (EMA_CLOSE-Ref(EMA_CLOSE,-P2)) / Ref(EMA_CLOSE,-P2) )*100;
//where EMA = exponential moving average, the parameters P1 and P2 are optional
_SECTION_END;

When I was conducting detailed and thorough tests of twenty-nine business strategies on about one hundred stocks in 2008, in order to find which classic indicators are the best and whether my own indicators are comparable with the classic ones, I found that during the back testing the S-ROC was the best of all the classic indicators - it was fourth in terms of the overall results of the tests on daily, weekly, and monthly stock prices from 1975 to 2008. The Ultimate Oscillator was only two places behind, followed by the simple moving average and the RSI Indicator. During tests on futures prices for the period 1985-2008 only the RSI indicator was the best of the classic indicators. This implies that traders are maybe depleting themselves by not using this indicator. It is interesting that at the very end of all the indicators was the Slow Stochastic Indicator.

Figure: Comparison of the classic Rate of Change for 14 days (green) with the Smoothed ROC (blue). The blue curve is more smoothed. For automated strategies, or strategies based on the "iron" discipline and fixed rules, the Rate of Change is preferable, because it removes small irrelevant deviations. 





Figure: The Smoothed ROC has two big advantages for me. Firstly, it is unbounded, and can thus far better capture buy or sell pressures; thanks to this it also better expresses divergences from the price, and in many cases it can better plot the trend line of the indicator, whose breakthrough above or below can serve as a signal. All these advantages are shown in the chart. It can be complementary to the RSI.





Figure: Here is an example of a simple strategy based on the Smoothed ROC together with the classic ROC. Because the Smoothed ROC expresses the direction of the trend better than the volatile ROC, but the ROC is faster at turning points of the development direction (trend changes), it is possible to combine both indicators. Buy when the more reliable Smoothed ROC is near its lows, and then use the intersection of the Rate of Change with the line of the linear regression for 50 days, calculated from the ROC (upper chart). However, because these two curves may intersect a number of times, ignore the first one, and only take into account the second one (at the second bottom or peak of the ROC there are usually already negative or positive divergences between the price and the indicator).




That is all about this indicator. The indicator can be found among the other indicators when using the graphical editor.



Petr Fiala



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