Oscillators are usually leading indicators that are most useful in analyzing securities or equities that are trading in a range, i.e., non-trending but can also be used to identify when the potential for a trend reversal has increased. Thus, oscillators are most beneficial when a security is in a horizontal trading pattern. Oscillators move higher and lower between overbought or oversold conditions and indicate potential turning points for a security as overbought and oversold conditions would, respectively, equate with find unsustainable levels of optimism and pessimism for the underlying security. In addition, oscillators tend to be leading indicators, which is also the reason why they are not as useful in a trending market, as they turn before the price does.
There are several oscillating indicators that can be used to analyze non-trending securities with the Stochastic Oscillator being one of the most popular. Other oscillators include Relative Strength Index (RSI), Rate of Change, Williams %R, and others. Each oscillator has a set of reference points that will generate entry and exit signals when the price action deviates too much from its normal range.
Shortening the period for an oscillator is generally preferred over increasing it. A shorter period oscillator will be more sensitive to price changes and will signal turning points quicker. Also, as oscillators are leading indicators, they usually turn before the price reverses its trend. As a result they should not be used to generate entry signals when the underlying security is in a strong trend.
Most oscillators have set reference lines to indicate the overbought and oversold areas. However, for some unbound oscillators you need to determine the upper and lower extremes over a relatively long period and draw the reference lines so that the oscillator only spends about 5% of the time beyond the reference lines. These reference lines should be adjusted on a regular basis. Some traders draw their own reference lines for oscillators that have predefined reference lines, such as the 30 and 70 lines of the RSI.
Average Directional Index
The Average Directional Index (ADX) is a lagging trend indicator designed by J Welles Wilder and indicates the strength of a trend. In other words, when a stock is moving strongly in an up swing or down swing, or whether it's moving in a trading range. ADX is part of an indicator system called Wilder's DMI, which consists of three lines: the +DI line, the -DI line and ADX line but it can also be used on its own to help determine key turning points in the market.
The ADX indicates the strength of the current trend rather than the direction of the trend and ...
Commodity Channel Index
The Commodity Channel Index (CCI) is a leading cycle indicator developed by Donald Lambert to identify the cyclical movement of commodities but it can also be used for stock, forex, futures and other securities. The CCI compares the typical price of a security to its simple moving average (SMA) and plots the result as an oscillating percentage.
Lambert recommended that a third of a complete cycle be used as the period for the CCI. Thus, if the cycle takes 60 periods to complete, then a 20-period CCI would be recommended. Once you have determined the period ...
Relative Strength Index
The Relative Strength Index (RSI) is one of the most useful momentum indicators around and is one of the most widely used oscillating indicators. The RSI determines overbought and oversold conditions by compares the magnitude of a security's recent gains to the magnitude its recent losses.
RSI is calculated using the formula: RSI = 100 - 100/(1 - RS) where RS is (Average Gain) / (Average Loss) for the specified period. However, Average Gain and Average Loss are not true averages as they are divided by the period of the RSI. The RSI varies between 0 and 100 ...
The Stochastic Oscillator is a leading momentum indicator that was developed by George Lane. It consists of two lines – the %K and the %D – which fluctuate between 0 and 100. The %K line represents the change in closing price with respect to the high and low of the specified period while the %D line is the average of the fast %K over another period.
The Stochastic Oscillator is used to determine when closing prices cluster together in the retraction of a developed trend and indicates potential entry and exit points when the %K line crosses the slow moving ...