The rate of change (ROC) is the speed at which a variable changes over a specific period of time. ROC is often used when speaking about momentum, and it can generally be expressed as a ratio between a change in one variable relative to a corresponding change in another; graphically, the rate of change is represented by the slope of a line.
ROC is used to mathematically describe the percentage change in value over a defined period of time, and it represents the momentum of a variable. The calculation for ROC is simple in that it takes the current value of a stock or index and divides it by the value from an earlier period. Subtract one and multiply the resulting number by 100 to give it a percentage representation.
ROC is an extremely important financial concept because it allows investors to spot security momentum and other trends. For example, a security with high momentum, or one that has a positive ROC, normally outperforms the market in the short term. Conversely, a security that has a ROC that falls below its moving average or one that has a low or negative ROC is likely to decline in value and can be seen as a sell signal to investors.
ROC is also a good indicator of market bubbles. Even though momentum is good and traders look for securities with a positive ROC, if an broad-market ETF, index or mutual fund has a sharp increase in its ROC in the short term, it may be a sign that the market is unsustainable. If the ROC of an index or other broad-market security is over 50%, investors should be wary of a bubble.