Besides trend indicators, oscillators are being an important part of the technical analysis. Technical indicators are mostly oscillators, rather than trend indicators. If trend indicators are applied almost always 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 analyze it. The idea behind using an oscillator to forecast future prices is to compare the current prices a currency pair makes with the oscillator move. It is being said that one of the two will form a fake move at some moment of time, and that one is not the oscillator. Therefore, if traders are supposed to base their trading decision on something, it is the oscillator 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 is not holding 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 are having a difficult time interpreting such a move. Nevertheless, if one is since markets are spending most of the time in consolidation, and not traveling in strong trends, then oscillators are a great tool to use.
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What Are Oscillators
Oscillators are technical indicators and therefore are an important part of technical analysis. They are based on mathematical formulas that are applied on past prices and the result is plotted on a separate window below the actual chart. As a rule of thumb, like it was the case with the trend indicators as well, the bigger the time frame is 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.
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 one, 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 normal as markets spend most of the time in ranges, or in consolidation, and oscillators are being built to profit from such an environment. This doesn’t make trend indicators less valuable, though.
The Most Important Oscillators
The list above shows no less than thirteen different oscillators offered with the default settings in the MetaTrader platform. Like with the trend indicators, any other oscillator can be imported in the trading platform, if it exists on the computer. We’re not going to discuss all the oscillators here, and even later in the project, we’re going to go into more details 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 RSI (Relative Strength Index). There is so much information written about this oscillator and so many interpretations that traders must have used it at least one time. 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 as to the distance the oscillator is traveling. The RSI is traveling between the 0 and 100 level, not an inch more. This makes its interpretation obvious and we will treat this oscillator in details later in a different Trading Academy article. The CCI (Commodity Channel Index) is the next in line of oscillator’s importance as it is extremely visible. This one, unlike the RSI, is traveling in negative territory, and this makes it even more interesting its interpretation. 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 that famous like the two mentioned above, but it is as powerful, and maybe even more powerful. Stochastics and MACD (Moving Average Convergence Divergence) are coming to 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 the ones to trust in ranging environments. Their standard interpretation is that they are showing overbought and oversold levels that are forming on a currency pair. As a rule of thumb, an overbought level is an indicator that market is going to turn, so a short trade is recommended. The opposite is true when the oscillator travels in the oversold territory: traders are looking to go long. This is happening most of the times, but not always. To make sure the fake signals are filtered, traders use other technical tricks. Such a trick is a divergence that might appear between price and 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 to be 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 are changing based on current prices variations – 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 are just some generalities about what oscillators are, where to find them, what are the most important ones and how to trade with them. As always, the more one goes into details, the more fascinating the technical analysis field becomes.
Recommended Further Readings
- Why Trading Forex?
– Advantages and disadvantages of trading the currency market, what are trader’s expectations and what is a realistic approach to follow
- What is a Forex Broker and Types of Brokerage houses
– Explaining what a Forex broker is and does, how the business should be organized, and how many types of Forex brokers exist.
- Forex Trading Sessions and Their Importance
– Explaining the differences between the three Forex trading sessions, what are their importance, ranking, etc.
- Forex Brokers Types – ECN or STP?
– What is ECN, STP, how d- brokers deal with client’s orders, advantages, and disadvantages of the tw- types.
- Why Trading Forex?
Other Educational Materials
- “Early Warning System in Forex Market.” Sihabuddin, Agus, Dedi Rosadi, and Nurdi Dwianto Wibowo. (2009).
- “Automatic FOREX Market Trading based on Technical Analysis.” Tealab, Ahmed AbdelHamid, M. Waleed Fakhr, and Amr Badr. Computing & Information Systems 15, no. 1 (2011).