OSCILLATORS

Oscillators indicate price change as opposed to price range. They allow structured comparisons of extreme momentum values that occurred in the past. Volatility tends to increase and decrease in direct relationship with price levels, causing higher peaks and lower valleys when prices rise.

OSCILLATORS

• Measure the rate of change in price movement and can be a precursor of price change
• Gauge the momentum or velocity of directional price movement
• Provide a way to determine overbought or oversold market conditions
• Show convergence vs. divergence – the trading range closes (converges) or opens (diverges).

COMMON OSCILLATOR STUDIES INCLUDE:

• Moving Average Oscillators
• Relative Strength Index
• Stochastic
• Directional Movement Index
• Average Directional Movement Index
• Moving Average Convergence/Divergence, or MACD

Moving Average Oscillators

The Oscillator study plots the difference between two moving averages of different lengths or types. The difference of two moving averages with different sensitivities to market action provides an indication of the development of a change in the market environment, such as the emergence of a new trend or a trend reversal.

To calculate an oscillator value:

• Calculate the moving averages
• Calculate the simple arithmetic difference between them using this formula:
  • OSCt = MA1 – MA2, where,
  • OSCt = the value of the oscillator for the current interval
  • MA1 = the first moving average
  • MA2 – the second moving average

When the Oscillator crosses zero it indicates a change in trend as the shorter, more sensitive, moving average is crossing over the longer, slower, moving average. The chart can help filter out poor trades so that positions are not taken if the market is trading sideways.

Movement away from zero indicates the shorter/faster average is accelerating away from the longer/slower average – this is associated with a strengthening trend. The CQG Correlation function can be used in a custom study to determine whether two moving averages move together. When they rise or fall at the same time and at the same rate, they have positive correlation – when they do not rise and fall at that same time and same rate, they have negative correlation. If correlation is above 99, this indicates that both averages are moving in the same direction at the same speed, so the market is trending strongly. When the two averages are converging the Oscillator is moving toward zero – this is generally associated with the termination of a trend.

A benefit of using an oscillator to measure the distance between the two averages, rather than simply watching their behavior, is that Overbought and Oversold levels may be identified. By identifying extreme points the oscillator indicates when a short-term trend is over-extended relative to its longer- term trend.

The oscillator is an unbounded study (in contrast to a Stochastic), so divergence usually occurs less frequently. Accordingly, it will follow the market higher or lower, but this makes defining specific OB/OS levels difficult. Given this characteristic, an oscillator should not be traded against simply because it is OB or OS, rather you should wait to see deterioration in its behavior.