By: John Robinson
What makes a price high or low in technical analysis? On a single day, trends are ubiquitous, and a price that surprises traders and analysts is often followed by another high on the charts, making the identification of tops or bottoms (or even the definition of what is high or low) a difficult task.
Oscillators are used to deal with this problem. Oscillators simply take the price action of a predefined period and compare it to the various averages of a previous era, trying to determine the strength or weakness of the underlying momentum. In other words, by the use of oscillators we are able to identify periods where the buyers or sellers are getting weaker in their conviction even as the price action registers higher highs, or lower lows, and as such, the trend cannot be maintained without a brief respite.
Some examples of oscillators are the MACD, RSI, Stochastics, and the Williams Percent Range Oscillator. Each of these oscillators has a different mathematical calculation, but they all measure similar events in a similar manner, and as such, a majority of oscillators are useful in ranging markets.
Due to the tendency of trending markets to easily exceed and break through the oversold and overbought levels of oscillators like the RSI, they are generally not very reliable in such market conditions. On the other hand, they can be very efficient in range conditions provided that adequate precautions are taken against false signals.
The best way of ensuring against false breakouts and whipsaws that eliminate the usefulness of oscillators is being selective in the choosing of actionable signals. With the Williams oscillator, for example, it is a good idea to only enter a counter-trend position when the indicator has remained in the overbought/oversold territory for a number of time units depending on the time frame of the chart. This will reduce the number of actionable signals, but will also make it likelier that the trades chosen will not disappoint.
Williams Oscillator is one of the indicators that work equally well in both ranging and trending markets. Another example is the MACD, and there are many more examples that come with a standard charting package. Still, oscillators are better suited to ranges, and they should be used with caution in a trending market.
As with all technical tools, an oscillator is best used with indicators from other classes in order to create a comprehensive picture of the price action. For example, one can combine a moving average crossover, an oscillator divergence, and a bullish/bearish pattern on the candlestick chart to reach at a more accurate entry point for a trade. And of course, to learn forex online, you must not just formulate strategies, but apply them again and again until your results are convincing satisfactory.
Oscillators are a valuable part of your arsenal, but your main weapons against a shrinking account are prudence and patience acquired over a long period of practice.
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