An oscillator is a type of technical analysis tool that moves between two values. These values, when built on an indicator to measure the strength and weakness of a trend. These types of indicators are also called momentum indicators. Oscillators show price deviation from its average value. Oscillators help to predict the approaching correction or the direction of price oscillation phase. Oscillators best suit the purpose of decision making when there is no vivid trend in the market.
What are Oscillator indicators?
Oscillator indicators have specific characteristics. In technical analysis, a trader gauges oscillator usually from 0 to 100. They mention price fluctuations in overbought or oversold conditions. When the oscillator’s value reaches upward, it’s an overbought condition, and when the oscillator reaches downwards, it’s an oversold condition.
Oversold and overbought conditions are an indication of a possible trend reversal. If the oscillator indicator reaches beyond its level, this means traders may start to prepare for a market reversal.
The traders can use oscillator indicators as a part of trend trading. This is because the price moves between two values creating a trend indicator. When the price rises, the oscillator rises above its level. Conversely, when the price drops, the oscillator declines below its level.
Oscillators are popular and widely used because they are leading indicators that can signal a possible trend change that is yet to start. This type of indicator oscillates between two limits, above and below a midpoint and its value helps to gauge the strength and momentum of a trend. Oscillators also typically signal if a market is overbought or oversold (meaning price is unjustifiably high or unjustifiably low), which could point to a reversal of the trend. This could be used to determine when to close open positions.
How to use Oscillator indicators?
When the price moves in a particular range, oscillator indicators follow these movements and signify an overbought condition when it reaches beyond 70 or 80. The trader may then look to take short positions. On the other hand, when price moves lower than 30 or 20, it’s an indication of an oversold condition, and traders may look to take long positions.
It’s important to note that the signals produced by oscillator indicators are sometimes most useful when the price moves in a certain range. When the price breaks these levels, a breakout occurs, and this is when a new trend starts to emerge. This can damage a trader’s position because a trend can go against his/her positions. This is the reason why many traders combine oscillator indicators with other forms of technical analysis.
Oscillators work best in ranging markets because in trending markets they can show overbought or oversold conditions too soon. Common things to look for are a midpoint cross, approaching maximum or minimum value and regular or hidden divergence. Oscillators are usually plotted with a line or histogram. There are many oscillators such as the Relative Strength Index (RSI), the Stochastic Oscillator, the True Strength Index and the Ultimate Oscillator.
Types of Oscillator Indicators
The most common types of Oscillator includes:
1. MACD
The MACD or moving average convergence divergence signifies price movements by combining two moving averages. It is commonly used for trend trading by swing and intra-day traders.
The MACD combines two moving averages: the 26-day EMA (exponential moving average) and the 12-day EMA. For calculations, it subtracts the 26-day EMA from 12-day EMA. There is also a 9-day EMA that acts as a signal line.
When the 12-day EMA crosses above the 9-day EMA, it’s a buy signal. On the other hand, when the 12-day EMA crosses below the 9-day EMA, it’s a sell signal.
2. RSI
The RSI is a momentum oscillator and measures the ratio of upward and downward price movements between the range of 0 and 100.
If the RSI is above 70, it’s an overbought condition; this means there is a strong buying pressure, and the currency pair is trading beyond its usual level. Conversely, when the RSI is below 30, it is an oversold condition.
3. Stochastics
The Stochastic indicator is a type of oscillator indicator and works similar to the RSI. Stochastics are mostly used in trending markets instead of ranging markets.
On the MT4 platform, the Stochastics illustrates two lines %K and %D. K% represents the Stochastics’ current value, while D% is the 3-period moving average of K%.
The Stochastics range between 0 and 100. If the value is below 20, it’s an oversold condition, and if the value is above 80, it’s an overbought condition.
Oscillator Indicators conclusion
Oscillator indicators measure the momentum of price, and also shows a slowing of momentum as the momentum of a financial instrument needs to slow down before changing direction. This addresses a weakness in retail trading, the fact that far too few traders pay attention to the importance of the rate of change.
The stochastic oscillator is one of the more common indicators, and it’s one that you will see in a lot of analysis. However, like any other indicator it is simply a tool that you will be using to navigate through the Forex markets, and like any other tool it is needed to be used in the proper settings and situations.
Oscillator Indicators can be used on your trading platform charts to help filter potential trading signals as part of an overall trading strategy. The Oscillator indicators are great for finding the strength or weakness of a trend. However, traders may wish to combine these indicators with other forms of technical analysis as a part of their forex trading strategies.
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