In this article, we will discuss
- Meaning of Oscillator Indicator
- How Do Oscillator Indicators Work?
- Type of Oscillating Indicators
Out of various metrics and indicators available in the stock market, oscillator indicators are one of the most extensively used metrics. As a trader, you don’t only need to understand the price fluctuations in a stock but also the momentum of such fluctuations.
By momentum, we mean rates at which the price of a stock changes. For example, if the price of a stock changes by 20% in 3 days, the momentum is said to be high. Whereas if the same change occurs within a period of 5 months, the momentum here is surely low.
However, the question that arises here is how do you identify this momentum in the price of a stock? This is where different indicators become a part of your trading analysis. In this blog, we have covered some of the most extensively used oscillating indicators that you can use for your market analysis. Read on to know more!
Meaning of Oscillator Indicator
As suggested by its name, these indicators oscillate between two values of a currency pair or an asset class. It forms a price band over two extreme values of an asset class, and these values are the highest and lowest values of an asset or the currency pair. Once the bands are formed, these indicators fluctuate between them by using a trend indicator.
The primary purpose of an oscillator is to help a trader gauge directional movement in the market and identify the strength of its momentum. In simpler words, it helps you identify if the price of an asset is going up or down and how strong this movement is.
When a trader can analyse how strong or weak a trend is, it becomes easier for them to identify short-term buying or selling opportunities.
How Do Oscillator Indicators Work?
If you are using an oscillator, your first step should be to identify two values and place an oscillator band on them. To pick the values, you might need the help of other technical analysis tools, such as chart patterns. Once you place an oscillator, it forms a trend indicator, which starts fluctuating between these two values, indicating their momentum.
If your oscillating indicator moves too high:
- A high indicator means a stock is overbought.
- Overbought stock means too many buyers have purchased the stock already, and now there are not enough buyers anymore to push the price of the stock further up.
- This signifies that the momentum has probably reached its peak and is at risk of turning around.
- In such cases, if the stock turns around, it either moves sideways or downwards.
If this oscillating indicator moves too low:
- A low indicator is the result of a stock being oversold.
- As you might have already guessed, an oversold stock is the result of too many sellers selling this stock. This means there are not enough sellers left to push the price of the stock further lower than what it is at present.
- This indicates a risk of loss in the downward momentum and can be a signal that the stock price is about to turn around.
- If the price turns around at this time, it either moves upward or sideways.
Type of Oscillating Indicators
Before we jump to understanding different types of indicators, let us clarify that no single indicator alone can help you turn around your trading game. Along with the help of these indicators, you also must possess risk management skills and trading analysis skills to be able to make better judgments.
However, this also doesn’t mean you should stop leveraging any tools or strategies at all. To help you master your trading skills, here are some of the most commonly used oscillating indicators that you must know about.
It is a momentum indicator that measures a security’s price change to find out its speed of change and its magnitude. This evaluation allows the indicator to measure if the price of that security is overvalued or undervalued. For those who don’t know, RSI is a line graph that oscillates between the values from 0 to 100. If you see an RSI reading of 70 or above, it is an indicator of an overbought condition. Whereas if its reading is 30 or below, it is a signal towards an oversold condition. Using an RSI oscillator indicator can help a trader in several ways.
A stochastic oscillator is made up of two lines viz. %K line and the %D line. The %K line is the actual value of the asset for each session. On the other hand, %D is a three-day moving simple average of %K.
The purpose of %K is to measure how close the price action touches the high price point of an asset. This point is called K.
%D, on the other hand, measures how close it reaches the low price point. If both %K and %D are above the centre line of the oscillator, it indicates a “buy zone”, and it is a ”sell zone” if the lines are below the centre line.
MACD is one of the oldest indicators and also one of the most reliable indicators used by day traders. As given in the name, convergence is when two moving averages move towards each other. On the other hand, divergence is when two moving averages move away from each other.
It incorporates the use of two exponential moving average crossovers and a histogram to help traders gauge the momentum. It oscillates within a band above and below zero. A line crossover of MACD lines can also give buy and sell signals.
It has two lines, one of which is a fast line and the other is a slow one. If the fast line crosses through and above the slow line, it is a buy signal. If it crosses below and through the slow line, it's a sell signal.
By now, you must have noticed something common in all oscillators. To use an oscillator, you must first pick two values on which you want to place the indicator. Once you place the indicator, it starts to oscillate between the values, thus creating a trend indicator for you to follow. They help you to read the present market condition of any particular asset on which you place them.
They are one of the best tools to find the direction of the price movement of a security. It also helps you to find the momentum of the directional movement. However, to be able to use these oscillators for maximum results, you must understand the basics of the technical analysis. Hence, they might not be a very handy tool for new investors.
Frequently Asked Questions
Q1. What are the three different trends in the market?
Ans. The different trends in the market are uptrends, downtrends and sideways trends. An uptrend is when the price of a security continues to rise, and if it falls, it is a downtrend. A sideway trend forms when the price of a security remains static.
Q2. What values indicate an overbought and oversold condition in a stochastics indicator?
Ans. In a stochastic indicator, an overbought asset condition is when the measurement crosses 80. When it reaches 20 or below, it is an oversold condition. However, if the momentum has been strong, it can last for an extended period and not always mean an immediate trend reversal.
Q3. Can I use oscillator indicators standalone?
Ans. While oscillator indicators give you an insight into the momentum and speed of price change of security, they work best when you combine them with other technical indicators. Combining them gives you more details and also allows you to make an informed decision.
Q4. What is a histogram in MACD?
Ans. A histogram is a visual representation of two MACD lines and the signal line. MACD lines are Exponential Moving Averages (EMA) of 12 and 26 periods, whereas the signal line is an EMA of 9 periods.
Q5. What are some other technical analysis indicators that I can use in day trading?
Ans. Some of the other popular indicators used in day trading are Bollinger bands, exponential moving averages, parabolic SAR, standard deviation, Fibonacci retracements, etc.
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