In investing circles, a rate of change is the amount of increase or decrease in the speed of output that is experienced when some element of change is introduced into a process or strategy. Also sometimes known simply as ROC, the rate of change seeks to determine how a given change affects the end result over a specified period of time. Calculating this type of shift in speed or momentum and its effect on a given investment strategy makes it easier to avoid variables that are likely to have an adverse effect, while also identifying changes that show promise of producing a more lucrative outcome.
One of the classic examples of calculating a rate of change involves monitoring the price of a given security or option and comparing that price to the current price of the underlying asset that supports that security. By introducing a possible shift in either price, it is possible to project the most likely impact that change will have on the performance of that investment in the future. For instance, if the underlying asset should lose value for some reason, this would likely have an adverse effect on the value of the security. By accurately determining how much of a change would occur, an investor can decide if that projected rate of change indicates that a downward shift in the underlying asset’s value would impact the value of the security enough to make ownership of that option undesirable.
Along with the projected outcome of the introduction of some new variable, the rate of change is also concerned with how quickly that change would generate predicted end result. This is often considered equally important to investors, since it helps to identify the window of time that is available to decide whether to buy, sell, or hold onto the security until just before the output is affected, or to take action immediately. Depending on the momentum of this change, properly timing the disposition of the security can mean the difference between obtaining the best possible return from the option and experiencing a loss from ownership of that security.
The value of calculating a rate of change is such that many financial and investment professionals consider the process essential to any technical analysis of an investment opportunity. Understanding the effect of different variables on the momentum of a given stock makes it easier to determine what action to take in order to achieve the most desirable outcome. This is particularly important when an investor currently holds a large volume of shares of the security in question, and stands to gain or lose a great deal, depending on how the value of those shares move.