Oscillators are group of countertrend, momentum based indicators that move above and below a horizontal axis that represents neutral market momentum.
These indicators offer an alternative to trend following strategies and work well in non-trending, sideways markets where a clear trend is not evident.
Interpretation of Oscillators
They can be used as an indicator of market extremes by showing overbought and oversold areas. Oscillators are often used as short term counter trend reversal indicators – they help to determine when a market is in an overbought or oversold condition. When the oscillator reaches an upper extreme, the market is considered to be overbought. When the oscillator line reaches a lower extreme, the market is considered oversold.
They can indicate when a trend is losing momentum. Increasing momentum reflects a powerful price trend, while weakening suggests a possible trend reversal. Momentum Oscillators are designed to identify these reversal points – and are used in both long and short term timeframes.
Most Oscillator indicators look very similar – they are plotted along the bottom of a price chart, with their peaks and troughs following those of the price chart. Some oscillators have a midpoint or zero line.
Generally speaking, when the oscillator has reached an extreme value in the upper or lower end of the band, this suggests that a price reversal is becoming more likely.
The crossing of the midpoint level or zero line is normally interpreted as a buy or sell signal in the direction of the trend.
Divergence between the oscillator and price is a warning of a possible reversal. This is the strongest and most important of all the signals provided by the oscillators.
Importance of determining trend. Oscillators are best used in a trending market to guage when the market is oversold in an uptrend for a buy entry and overbought in a downtrend for a sell entry.
The family of technical indicators known as Oscillators includes: Relative Strength Index (RSI), Stochastics, Aroon Oscillator, Commodity Channel Index (CCI), Moving Average Convergence Divergence (MACD), Rate of Change (ROC).