Ultimate Oscillator Trading Strategy - Definition & Use Options

Christopher Lewis

One of the more interesting indicators out there is the ultimate oscillator. It is very useful for traders to identify overbought and oversold conditions, but perhaps more importantly than that, it is used to find divergences in the market. The ultimate oscillator, unlikely many other oscillator indicators, is built for this specific task.

What is the Ultimate Oscillator and How Is It Calculated?

The ultimate oscillator is an indicator that was developed by Larry Williams in the mid-1970s to measure the pricing momentum of a stock or commodity via multiple time frames. Since then, it has been used in many other markets, as it tends to be less volatile and produce fewer signals, and therefore generates fewer whipsaws than many other similar indicators. Signals are generated via divergences, and as it is generated on multiple time frames, it takes much more to create a signal from this indicator than most of the similar ones you may be used to using.

The ultimate oscillator is an indicator that has its own window on the chart, like any other oscillator. It also oscillates between two major levels, 0 and 100, like many other oscillators. Readings below the 30 level indicate an oversold situation, while readings above 70 indicate the price as overbought. Like many other oscillators, traders can use divergence between the signal and price action on the chart to identify a trade entry signal. In other words, when price moves in the opposite direction of the indicator, it shows that a trade could be setting up.

One of the things that makes the ultimate oscillator so different from other oscillators such as the MACD indicator, the stochastic oscillator, and many others is the fact that it uses multiple time frames to smooth out values. It then claims to be a more reliable indicator of momentum, offering fewer false signals. This has been worked around by Mr. Williams by including the 7, 14, and 28 periods. By using these three different price periods, all three need to line up in the same direction and tell the same thing to produce a trade signal. This helps filter out the noise of unimportant day-to-day price movement.

Interpretation

The ultimate oscillator calculates buying pressure, which was defined by Williams as the closing price of the period, less the low of that period, or prior closes, which ever one was lower. The indicator then calculates the true range, which is the current period’s high or the prior close, whichever one is higher, minus the lowest value of the current period’s low or the prior close. It records this value for each period, (7, 14, and 28) to create the true range of volatility.

Finally, the ultimate oscillator calculates a weighted average from all three values with the value of the 7-period allocated four units, while the 14-period has a weighting of two, and the 28-period has a weighting of one.

You don’t have to worry about the details of the calculation as the indicator will do it for you. The indicator gives greater weighting to the shorter time frames than the longer one, although the longer one smoothes out the indicator’s reading.

What is the Difference Between the Ultimate Oscillator and the Stochastic Oscillator?

The stochastic oscillator is often compared to the ultimate oscillator. While the stochastic oscillator is excellent for rangebound markets, the ultimate oscillator can produce signals in both rangebound and trending markets, although it should be noted that trending markets are almost always when you see signals. The stochastic oscillator performs miserably in a trending market, thereby making it a very specialized indicator.

Ultimate Oscillator Trading Strategy: Examples of the Ultimate Oscillator in Action

In the price chart shown below this paragraph, you can see that I have a couple of circles on the USD/CAD daily chart. Notice that the ultimate oscillator had reached a reading of 20 in early May. Notice that the indicator then started to rise from the bottom, from roughly 20, while the price continued to fall. This is what is known as a divergence (when an oscillator moves in the opposite direction of the price). This often signals an impending reversal. As the market started to turn around, the oscillator continues to go higher. The buy signal was created roughly 2 weeks ahead of a major breakout. This is a great “heads up” as to something changing in the market’s structure. Usually, I will use this indicator to give me trading ideas and then wait for some type of breakout as confirmation. You can see clearly that we had broken above the 1.2150 level just a few days after bottoming, and then rallied all the way to the 1.29 handle over the next couple of months.

Ultimate Oscillator Buy Signal

Ultimate Oscillator Buy Signal

In the second example presented in the below price chart, you can see that Ethereum had been in a very strong run between the months of April and May. Notice the circle in the ultimate oscillator window, as the oscillator peaked above the 80 level very briefly, and then started to fall. Notice that Ethereum continued to rise over the next couple of days. This was another “heads up” type of sell signal that this indicator is known for. This is a perfect example of a signal to take profits had you already been participating in the long-term run higher.

Shortly after the ultimate oscillator broke back down, Ethereum dropped by over 50%. At the very least, this should have had you tightening up stops as soon as you saw the divergence between the oscillator and price, saving you massive potential losses.

Ultimate Oscillator Sell Signal

 Ultimate Oscillator Sell Signal

Limitations of Using the Ultimate Oscillator

One of the biggest strengths of using the ultimate oscillator is that it produces fewer signals than similar indictors. Depending on the type of trader you are, this might be thought of as a limitation, because it will have you “sitting on your hands” quite a bit. However, in trading, it is important to sit on your hands when there are no good trading opportunities. The ultimate oscillator tends to favor position and swing traders, and it should be noted that on shorter time frames it may not perform quite as well. If you are looking for higher timeframe position trading, the ultimate oscillator tends to be quite useful.

Final Thoughts

The ultimate oscillator is a handy tool to find divergence in the market. If you are somebody who uses MACD, RSI, or CCI for divergence signals, you will likely find this indicator useful in your trading. It will be a natural fit, as it shows quite clearly what you are looking for in those oscillators. However, if you are a short-term trader, it probably will not do you much good, because shorter-term traders need much quicker signals.

The ultimate oscillator does at well at keeping you out of trouble during rangebound markets, and it is also a great tool to find good exits to longer-term trades. After all, if you choose to only follow the longer-term trend, you need something to tell you when it is time to take profits and perhaps wait for a pullback. The ultimate oscillator is great at doing this.

One major issue with the ultimate oscillator is that it is not necessarily included as a preset within all trading platforms, so you may have to find it somewhere. Nonetheless, there are plenty of free add-ons available out there that allow you to customize your terminal.

FAQs

How does the ultimate oscillator work?

The ultimate oscillator calculates buying pressure on three different time frames based upon recent price action, then produces a smoothed weighed average which can be used to indicate whether an asset is overbought or oversold.

Which oscillator is best?

Different oscillators have different uses, but the ultimate oscillator is the most effective oscillator indicator at determining divergence, which can be the basis of a profitable trading strategy.

What is UO in technical analysis?

In technical analysis, “UO” stands for the ultimate oscillator indicator.

How to use the ultimate oscillator?

In Forex and CFD trading, the ultimate oscillator is usually most effective when applied to the daily time frame. When the price is oversold but price action looks bullish, you have a long entry signal, and vice versa.

What does the ultimate oscillator do?

The ultimate oscillator is an indicator which shows whether the price of an asset is overbought or oversold on multiple time frames simultaneously. When overbought or oversold is indicated, a trade entry can be considered.

Christopher Lewis

Christopher Lewis has been trading Forex for several years. He writes about Forex for many online publications, including his own site, aptly named The Trader Guy.

Did you like what you read? Let us know what you think!

exclamation mark

Please make sure your comments are appropriate and that they do not promote services or products, political parties, campaign material or ballot propositions. Comments that contain abusive, vulgar, offensive, threatening or harassing language, or personal attacks of any kind will be deleted. Comments including inappropriate will also be removed.

0 User comments

exclamation mark

Please make sure your comments are appropriate and that they do not promote services or products, political parties, campaign material or ballot propositions. Comments that contain abusive, vulgar, offensive, threatening or harassing language, or personal attacks of any kind will be deleted. Comments including inappropriate will also be removed.

Read more
Add new comment
This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.