Oscillators are a group of indicators
that confine the theoretically infinite range of the price action into more
practical limits. They were developed due to the difficulty of identifying a
high or low value in the course of trading. Although we may have mental
concepts of what is high or low in a typical day's price action, the volatile
and chaotic nature of trading means that any high can easily be superseded by
another one that sometimes follows on the heels of a previous record, and
negates it swiftly. In short, practice and experience tell us that prices in
themselves are very poor guides on what constitutes an extreme value in the
market, and. oscillators aim to solve this problem by identifying indicator
levels that hint at tops or bottoms, and helping us in the decision process.
There are two ways of using an
oscillator. One is to determine turning points, tops and bottoms, and this
style is usually useful while trading ranges only. Oscillators are also used
trending markets, but in this case our only purpose is joining the trend. Highs
or lows, tops or bottoms are used for entering a trade in the direction of the
main trend.
There are many kinds of oscillators
available for the trader's choice, and although they have different names and
purposes in accordance with the creators' vision, there are a small number of
distinctions that determine which group an oscillator falls into, and where or
how it can be used, as a result.
It is possible to group oscillators
first on the basis of their price sensitivity. Some, like the Williams
Oscillator, are very sensitive to the price action. They reflect market
movements accurately, but under the default configuration do not refine movements
into simpler, clearer signals for the use of the trader. Oscillators like the
RSI are less volatile, and are more precise in their signals, but also less
sensitive to the price action, which means that two different movements of
different volatility and violence may still be registered in the same range by
the RSI, while the Williams Oscillator analyzes it more accurately to reflect
its violent nature. Some oscillators provide limit values to determine various
oversold/overbought levels, while others create their signals through the
divergence/convergence phenomenon alone. In general, oscillators that provide
oversold/overbought levels are useful in range patterns, others are mostly used
in trend analysis.
Let's take a look at a few examples to
have an idea of the different types oscillators used by traders.
1.
MACD:: The MACD is one of the most commonplace indicators.
It is a trend indicator, and it is useless in ranging markets. MACD has no
upper or lower limits, but does have a centerline and some traders use
crossovers to generate trade signals.
2.
RSI: RSI is another commonplace and relatively aged
indicator used by range traders. It is almost useless in trending markets.
3.
Williams Oscillator: An excellent tool for analyzing
trending markets, especially those highly volatile, the Williams Oscillator
requires some commitment and patience to get used to, but it is popular, partly
due to its association with the trading legend Larry Williams.
4.
Commodity Channel Index: The CCI is particularly useful for
the analysis of commodities and currencies that move in cycles. It is not as
popular as the others mentioned above, but it has been around for some time,
and has stood to test of time.
The indicators are examined in greater
detail in their own article.
Using the Oscillators
Each oscillator has its own how-to of
trading the markets. Some provide the aforementioned overbought/oversold levels
for trade decisions, others are used by traders through various technical
phenomena to generate the desired signals. But it is generally agreed that the
best way of using this indicator type is the divergence/convergence method.
Although this method is also prone to emitting false signals at times, it does
not occur as frequently as the other technical events such as crossovers or the
breach of overbought/oversold levels, and is therefore preferred over other
styles of analysis.
Conclusions
Oscillators can be used in ranging and
trending markets, and since, depending on the timeframe, even a range pattern
can be broken down to smaller trends, it can also be possible to use trend
oscillators in range trading as well. Creativity and experience are the main
requirements for the successful use of these versatile technical tools. If you
seek to use them in your own trading, it is a good idea to do a lot of
backtesting, and demo trading just to get used to the parameters, and to gain
an idea of what works and what does not. In time, your own trading style will
develop which will determine the indicator types that you enjoy most and find
most versatile and useful for you. You can begin by studying the various
articles on oscillators at this website.
..............................................................To be continued
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