Oscillators

Alongside trend indicators, oscillators are an important part of technical analysis. Most technical indicators are oscillators rather than trend indicators. While trend indicators are almost always applied on top of the actual chart on current prices, oscillators are not. When an oscillator is selected, a separate smaller window will appear at the bottom of the screen. In that window, the oscillator appears, and traders can analyse it. The idea behind using an oscillator to forecast future prices is to compare the current prices a currency pair is making with the oscillator’s moves. Usually one of the two will form a fake move at some moment in time, and that one is not the oscillator. Therefore, if traders are supposed to base their trading decision on something, it is the oscillator’s move that should be trusted, and not the actual price levels. This is, like anything in trading, a relative statement. Sometimes in strong trends this statement does not hold, as the oscillator after all is just a mathematical formula based on past prices. If current supply and demand levels are so distorted and the trend is increasingly aggressive, building more and more energy with every level that is broken, then oscillators have a difficult time interpreting such a move. Nevertheless, in situations where markets are spending most of the time in consolidation, and not travelling in strong trends, then oscillators are a great tool to use.

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What Are Oscillators

Oscillators are technical, and therefore are an important part of technical analysis. They are based on mathematical formulas that are applied on past prices, the result being plotted in a separate window below the actual chart. As a rule of thumb, as was the case with the trend indicators as well, the longer the timeframe used, the stronger the oscillator’s implications. For example, if an oscillator is showing a possible buy signal on the hourly chart, it may very well be that on the daily chart the ongoing signal is a short one.
Oscillators -1

Where to Find Them

The MetaTrader platform has almost the same path for oscillators as it has for trend indicators. Clicking the Insert tab and selecting the Indicators tab, the Oscillators tab appears. As you can see in the image above, compared with the trend indicators, there are more oscillators offered by default. This is not just a MetaTrader issue, but reflects a reality: Oscillators are more numerous than trend indicators. This is only logical as markets spend most of the time in ranges, or in consolidation, and oscillators are built to profit from such an environment. This doesn’t make trend indicators any less valuable, though.

The Most Important Oscillators

The list above shows no less than 13 different oscillators offered with the default settings in the MetaTrader platform. As with the trend indicators, any other oscillator can be imported onto the trading platform, if it exists on the computer. We’re not going to discuss all the oscillators here, but later in the project, we’re going to go into more detail on some of the oscillators listed above. The reason for that is that they all show the same thing, and they work best in ranging markets. The king of all oscillators, and the most famous one, is the Relative Strength Index (RSI). There is so much information written about this oscillator, and so many interpretations, that every trader must have used it at least once. The RSI is based on a mathematical formula, and plots a line below the actual chart. All oscillators “oscillate” between some defined values. In some cases, those values are well defined, in the sense that it is not possible to have a print bigger or lower that the maximum and minimum value as it is defined by the oscillator. In some other cases, there are no boundaries to the distance the oscillator travels. The RSI travels between the 0 and 100 level, and not an inch more. This makes its interpretation obvious, and we will treat this oscillator in detail later in a different Trading Academy article.

The Commodity Channel Index (CCI) is the next oscillator in terms of importance, as it is extremely visible. This one, unlike the RSI, travels in negative territory, and this makes its interpretation even more interesting.

The Momentum oscillator always keeps a trader on the right side of the market, and the zero line is key when trading with it. It is not as famous as the two mentioned above, but it is as powerful, and maybe even more so. Stochastics and the Moving Average Convergence Divergence (MACD)  complete the list of the most important oscillators, but all the ones you can see in the image above are important. Moreover, their interpretation is pretty much the same, and this makes trading with multiple oscillators a waste of time.

How to Trade with Oscillators

Oscillators are mostly to be trusted in ranging environments. Their standard interpretation is that they show overbought and oversold levels that are forming on a currency pair. As a rule of thumb, an overbought level is an indicator that the market is going to turn, so a short trade is recommended. The opposite is true when the oscillator travels in the oversold territory: Traders  look to go long. This happens most of the time, but not always. To make sure the fake signals are filtered out, traders use other technical tricks. One such trick is based on a divergence that might appear between the price and the oscillator. The concept of diverging moves is one that is widely used in the technical analysis field, and we will treat it accordingly later in our project. The general idea is to look for divergences when the oscillator is in the overbought or oversold territory. This strengthens the signal, and the probability of the trade being a profitable one increases. Yet another way to look at oscillators is to plot different ones on the same chart, make sure they are not repainting (when an oscillator repaints it means that historical levels the oscillator reached change based on current price variation, and hence, no back-testing is possible) and look for crosses between them. This is a great tool for scalping as profitable trades are generated.

These then are just some generalities about what oscillators are, where to find them, which are the most important ones, and how to trade with them. As always, the more one goes into detail, the more fascinating the technical analysis field becomes.

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