Introduction to Oscillators
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)
See also: