Oscillators are a very helpful type of indicator for any trader with a trend-following approach. They help a trader define short periods of market extremes and indicate trends losing momentum. Also, one of the main challenges of any trend-based strategy are trading periods without a dominating trend where prices move in a horizontal price range. In these periods, the oscillator enables a trader to still generate tradable predictions about future price movements.
Therefore, any trader should know how to read and interpret oscillators.
While there are a number of different oscillators, they can all be interpreted the same way. Usually, the oscillator is displayed in a separate window below the price chart. Oscillators form a flat band on which the value of the oscillators moves up and down to create a line. Some oscillators have a middle line that divides the bandwidth of the oscillator into an upper and a lower half. Depending on the oscillator, the middle line usually resembles the value 0. Other oscillators range between 0 and 100 and have no middle line.
An oscillator is a secondary indicator, meaning that it has to be combined with trend analysis to generate valid trading signals. Trading an oscillator in the direction of the dominating trend is an absolute necessity for its successful use.
In general, all oscillators have predefined areas near the top and bottom of their range in which price moves are considered too extreme and a correction imminent. Also, a value near the lower end of the range indicates that a trader should be buying, and a value near the upper end of the range indicates that a trader should be selling. If there is a middle line in an oscillator, the crossing of that line is usually considered a buy or sell signal.
There are three scenarios in which an oscillator can greatly benefit your trading:
1) When an oscillator reaches a reading near the limits of its range the underlying asset is to be considered overbought with a value near the top of the range and oversold with a value near the bottom of the range. This should be a warning to the trader that the movement has extended too far and is weakening. You could make it a rule to not invest in rising prices when the oscillator is near the top of the range, and not to invest in falling prices when the oscillator is near the bottom of the range.
2) When the oscillator reaches a new extreme position, either a new high or low, but the price has not reached a new peak or bottom. These differences between the oscillator’s movement and the price’s movement are usually a significant signal for a weakening trend.
3) When the oscillator crosses its middle line this can be an important signal in the direction of the main trend. In an uptrend, a bullish signal is created when the oscillator crosses its middle line upwards. Vice versa, in a down trend a bearish signal is created when the oscillator crosses its middle line downwards.
While there are too many oscillators to mention them all in this article, we will make sure to list you the most important oscillators. Each of them will have its own article, in which you can learn more.
Oscillators like the Average True Range can help you predict the expected trading range, which is especially useful for traders of no touch options. Stock traders also rely heavily on contrary opinion oscillators.