What is an Oscillator Indicator?
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Oscillator indicators are tools of technical analysis that plot two bands, a high and a low band, around an indicator trend line that moves in between them. Oscillator indicators help to analyze a price trend momentum and its strength and are generally used to identify overbought and oversold market conditions which signal possible trend reversals and times to open or close a position. The values of the oscillator range (expressed, for example in percentage terms for certain indicators) are bound by the upper and lower extreme limits based on the recurringly updated price performance that somewhat act as support and resistance levels, with the price trend between them sending many signals about the trend and its possible reversal or continuation.
How to interpret oscillators?
The main advantage of these indicators is their ability to demonstrate a relatively clear trend in the price of an asset, its momentum. What is price momentum though? In simple words, a momentum is a measure of how fast price of a security changes, so the faster price increases over time, the higher its momentum is and vice versa. Often a change in momentum is an sign that the current price trend begins to weaken and a trend reversal may be approaching soon. Oscillator indicators help to visually assess that by plotting a trend line of the price which ‘oscillates’ or moves in between the upper and the lower limit around the middle value (with a value of 0) and can be used to interpret market conditions. An overbought condition can be inferred from when the level of the oscillator reaches its upper band and vice versa, when the indicator approaches its lower value the asset is likely to be oversold. A trader can then use the overbought signal as an opportunity to sell an asset and oversold as an opportunity to buy. Usually these indicators are not used on their own but rather in combination with other tools of technical analysis.
Oscillator indicators vary in the way they are constructed and also in the way a trader interprets different levels such an oscillator reaches. Below you can find a guide to all the different types of oscillator indicators eToro has to offer.
Oscillators on eToro
Price oscillator, like most other oscillators, is used to identify points of possible price reversals and trading signals, as well as the overall volatility of an asset. A simple price oscillator is a trendline which is made by taking the difference of two moving averages (calculated in either percentage or point terms), one of a shorter period (‘short cycle’) and a longer period moving average (‘long cycle’). The default time periods for the two moving averages is always 12 and 26 days with EMA used as the moving average. You can always adjust the duration of the two cycles as well as the type of the moving average on eToro platform. The indicator trendline oscillates between the upper and the lower band around the zero trendline. An upward trend and a buy signal can then be inferred from when the indicator crosses the zero line from below and into the upward direction and vice versa, when the indicator drops downwards, a sell signal can be inferred.
You might noticed that this indicator is very similar to a Moving Average Convergence Divergence Indicator, which is another indicator that follows a trend of a price. The difference here comes from the fact that MACD measures the difference between two moving averages in absolute or dollar terms, while a price oscillator calculates it in terms of percentages or points. This can be quite advantageous as this form of the indicator allows you to compare different assets which is not the case for MACD.
Aroon oscillator is constructed by taking the difference of two other indicators, Aroon Up and Aroon down, and identifies which one is stronger over a certain time period. Aroon Up indicates how strong an upward trend is by taking the time between the beginning of a time period and the time when the highest closing price of an asset was achieved over that period (the default period is 14 but you can always adjust that on eToro); when the price is reaching new higher levels over the period the indicator approaches the value of 100 and vice versa, when the price has only been going down the indicator approaches the value of 0. Aroon Down is then calculated in the opposite way, by finding the time price reaches its new lowest points. Values of above 0 for this indicator mean that Aroon Up is above Aroon Down with the price reaching new higher levels over the period and vice versa. Because this indicator is either positive or negative most of the time it is quite easy to interpret: an upward trend is happening when the price is above zero and a downward if the price is moving below it. You can also interpret the strength of a trend; Aroon oscillator ranges between 100 and -100 above and below the zero crossover line in the middle; when the indicator approaches either of the extremes this signals strong upward or downward trends respectively.
When the oscillator takes values in the middle range, between 50 and -50, the trend is considered to be weaker overall. Also note that Aroon oscillator over shorter time periods is of course much more sensitive than indicator over a longer timeframe, but the choice of the timeframe of course depends on your trading strategy.
This awesome oscillator is a histogram-like indicator and is used to identify momentum of the chosen asset as well as possible price reversal conditions. This indicator is calculated by taking the difference of the latest 5 period bar moving average (a shorter time frame) and a 34 period bar moving average (longer time period), and also considers midpoint bar values rather than closing prices to do so. Note that the bars of this indicator are of two colors, red and green. A bar is green when the latest price’s midpoint is above the midpoint of the preceeding bar, so when this bar is of a higher value than the preceeding bar, and vice versa, the color is red when the bar is below the previous bar.
The zero line is likewise important here; bars above zero means that the values of the shorter period moving average are above the ones for the longer time period and vice versa. When the bars of the histogram are above the zero line the market is said to be moving upward as the momentum of the short-term period is faster than the longer term momentum; when the oscillator is below zero the momentum is then downwards or bearish.
How could you use this indicator? When the oscillator is crossing over the zero line from above to below (bearish crossover), this could be interpreted as a potential sell signal and when it is crossing over into the above zero line region, this is a potential for a buying opportunity.
Chande Forecast Oscillator
Chande forecast oscillator, like the name says, is used for price forecasting and it used for the basic purpose of identifying whether the price is expected to increase or decrease. This indicator is then a little different to other oscillators: instead of showing that there is a certain probability of a price reversal or a trend change it directly predicts the price of an asset in the upcoming period. Chande Forecast oscillator is constructed by taking the difference (in percentage terms) between the closing price of an asset and the price forecasted for a certain time period using a linear regression. The interpretation of this indicator is then quite simple: when it is above zero then the price predicted by the regression is over the actual closing price and it is less than zero when the forecast is below the closing price.
Chande Momentum Oscillator
This indicator is in many ways similar to a relative strength index (RSI), ranging between -100 and 100 and signals overbought conditions at levels of above 50 and oversold from below -50, like shown on the image below. It is calculated as the difference between the sum of higher closing prices over a period and the sum of all lower closing prices for that period, times 100. Chande momentum oscillator is rarely used on its own and is usually used in conjunction with other indicators. CMO indicator can not only be used to signal trend reversals and therefore entry and exit points, but can also be indicative of the strength of a trend: when the value of the indicator is closer to the zero level, the asset is considered to be range-bound and is therefore trading sideways. When the indicator is far away from the middle of the value range, it signals a strong bullish or bearish trend.
Detrended Price Oscillator (DPO)
Unlike other indicator, DPO focuses on price’s peaks and troughs, and as the name suggests, removes price trends to make it easier to spot cycles by removing temporary ‘noise’. Detrended values for the indicator are found by subtracting value of a simple moving average (or any other of your choice) over a time period (14 by default on eToro) from the price of your chosen asset. The actual trend line of this indicator is quite similar to the actual price without the major underlying trend. When a higher peak is forming there is a chance for an upturn in price and when a lower peak of the indicator is forming there is a possibility of a downturn. Like with other indicators, a possible buy signal is generated when the oscillator line crosses the zero line below and sell when it crosses from above into the downward direction.
Fractal Chaos Oscillator
This indicator takes values between 1 and -1 and detects the most minor price changes by dividing large trend into simpler patterns that helps predicting possible price reversal points. As the name of this indicator suggests, the stronger a trend in price the more ‘chaotic’ the indicator is and the further away from the zero line it is. A ‘fractal’ in this context refers to a repeating pattern in price that happen despite the irregular or ‘chaotic’ movements of a price. A higher the value of the oscillator then signals a possible buy opportunity and lower values suggest sell signals.
Pretty Good Oscillator
Values for the pretty good indicator are calculated by taking the difference between the current closing price of an asset and its moving average over a certain time period, for example 14 days (you can always adjust that value) and then dividing the result by the exponential moving average of true range. A buy signal happens when the indicator crosses the zero line from below and upwards and a sell signal when it drops from above. Overbought and oversold regions are shaded in, just like on the image below.
Prime Number Oscillator
This indicator may appear quite unusual, it is used to determine potential price turning points and is calculated as the difference between the closest prime number and the respective price series. The unusual appearance of this indicator however makes it somewhat easy to interpret it: when this oscillator is at a high value for quite some time on the chart (for example, two consecutive periods), a potential sell signal is generated and vice versa, when PNO is low for several periods on the negative part of the chart, a buy signal is generated.
This indicator is used to identify momentum in a price of an asset across three different timeframes, blending in price action over the short, medium and long-term. Why is that useful? Well, the ultimate oscillator attempts to correct the problems of oscillators that are used over single time frames separately, as for example, a short-term oscillator indicator tends to signal a peak before the price action and vice versa, long-term oscillators tend to be late to indicate price reversals. By combining three time periods through a weighted average (7, 14 and 28 days by default and can be adjusted on eToro), this indicator tends to be less volatile and also does not generate as many trading signals as the others. The ultimate oscillator takes values between 0 and 100, and an overbought condition can be inferred from the indicator taking values above 70 (a bearish divergence) and oversold conditions happen when the indicator takes values below 30 (a bullish divergence).
When the indicator reaches values of 70 and above price divergence is moving from an overbought condition and is likely to end up in a price reversal of a downward direction, creating a sell opportunity for a trader; likewise, when the indicator falls under 30 and below, price divergence is moving from oversold conditions and is likely to reverse upwards, signalling favorable buy conditions.
Trading signals occur when the price of an asset is moving into a direction that is opposite to the direction of the indicator. The major benefit of this oscillator is the fact that is indicates fewer false price divergences which tend to happen for oscillators with a single timeframe and is somewhat a better indicator of price momentum. Beware however, that this smoothing out effect may get rid of not only false trading signals but also of potentially good ones as price reversals don’t always originate from overbought and oversold conditions. That is one of the reasons why traders use this indicator in combination with several others.
A note of caution
Despite all of the benefits of oscillator indicators they can at times be misleading depending on the market conditions. For instance these indicators are mostly used in ranging markets as in trending markets there is a risk of them signalling conditions of an overbought or oversold market too soon. You should be aware of the possible incorrect signals they provide and their interpretation or perhaps confirm them with other indicators.
Hopefully now you have a better understanding of the different typesof oscillator indicators available on the eToro platform. Remember that trading always involves capital loss risk and enjoy trading on the platform. Best of luck!
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