What is it?
Smoothed Rate of Change (S-RoC) is a refinement of Rate of Change (RoC) that was developed by Fred G Schutzman. It differs from the RoC in that it based on exponential moving averages (EMAs) rather than on price closes. Like the RoC, Smoothed RoC is a leading momentum indicator that can be used to determine the strength of a trend by determining if the trend is accelerating or decelerating. The S-RoC does this by comparing the current EMA to value that the EMA was a specified periods ago. Thus, a 7-day S-RoC compares the current EMA to the value that the EMA was seven days ago. The use of EMAs rather than the price close illuminates the erratic tendencies of the RoC.
How is it calculated?
RoC is calculated in three steps. First, the EMA is calculated. Then the momentum of the change in the EMA is calculated by subtracting the previous value of the EMA from the current EMA. Finally, the result is divided by the previous value of the EMA and multiplied by 100 to give a percentage. As the S-RoC is a RoC of EMA, it takes two periods: the period of the EMA, with the default being 13; and the period of the RoC, with the default being 21. The formula is:
S-RoC = ( Current EMA - Previous EMA ) / ( Previous EMA ) x 100
where the previous EMA is the value that the EMA was at specified period ago. The result is a percentage that is plotted as an oscillator that oscillates between 100% and -100%.
How is it used?
As with the RoC oscillator, the key consideration when using S-RoC is the center line. When the price of the underlying security is in an uptrend, a buy signal is generated when the S-RoC falls below its center line and starts to turn back up. When the price of the underlying security is in a downtrend, a sell signal is generated when the S-RoC moves above its center line and starts to turn back down.
In ranging markets (non-trending) the overbought and oversold reference lines are a key consideration. However, the reference lines must be drawn manually around the extreme areas of the S-RoC. As a general rule, the S-RoC should not spend more than 5% of the time above or below the reference lines. When the underlying security is in a range, a sell signal is generated when the RoC moves out of the overbought area over the upper reference line. Similarly, a buy signal is generated when the RoC moves out of the oversold area from below the lower reference line.
Divergence is another consideration. Bullish divergence occurs in a downtrend when the price makes a lower low but the S-RoC makes a higher low. This indicates that there is a weakness in the downtrend and that a trend reversal is quite probable. A bearish divergence occurs when the price makes a higher high but the S-RoC makes a lower high low. This indicates a weakness in the uptrend with a strong probability that the trend will reverse soon.
Entry signals are also generated when a trend lines drawn on the S-RoC is violated.