Oscillators

What are oscillators?

Oscillators are technical indicators that measure a stock’s momentum as it oscillates between an overbought and an oversold zone and then give a buy/sell signal. Oscillators have recently caught the fancy of most traders. Oscillators give out ‘crossover’ model signals to indicate a change in trend.
Oscillators are typically plotted in two ways.

  1. Banded oscillators: Plotted within a range between 0 and 100, in this method, the zone between 0 and 30 is considered the ‘oversold’ zone while the zone between 70 and 100 is considered ‘overbought’. When the oscillator reaches an extreme value in any end, either up or down, the implication is that price has moved too fast and too far. This would warn investor to be ready to face a sudden reversal or a period of consolidation or sideways movement. Investors should typically buy when oscillators feature in the lower end of the range and sell when the oscillator line reaches the upper end of the range.
  2. Centered oscillators: The other way to plot oscillators is on either side of a zero line and the oscillator moves between positive and negative values. Called ‘centered oscillators’, they fluctuate above and below a central point or line. These oscillators are good for identifying the strength or weakness, or direction, of momentum behind a security’s move. In its purest form, momentum is positive (bullish) when a centered oscillator is trading above its center line and negative (bearish) when the oscillator is trading below its center line. MACD (discussed later) is an example of a centered oscillator that fluctuates above and below zero.

What are ‘oversold’ and ‘overbought’ conditions?

  • Oversold is a condition where it appears that a stock has declined to the point where the selling is over and buyers will likely step in and push the stock higher.
  • Over bought is a condition where it appears that a stock has reached a price peak and is now likely to turn down.
  • However, overbought is not meant to act as a sell signal, and oversold is not meant to act as a buy signal. Overbought and oversold situations serve as an alert that conditions are reaching extreme levels and close attention should be paid to the price action and other indicators.

An example of relative strength index (RSI) , one of the most commonly used oscillators is given below.

oscillators

The blue line on the picture above is the stock’s RSI which moves within a band of 30 -70. When ever the RSI breaches the 30 mark it signals an oversold situation and the stock bounces back. The zone above 70 is considered as overbought. Note that the stock price has shown a drop in price after it breaches the upper limit of the band at 70.

A few words of caution

Too Many indicators and oscillators!

The best technical indicators are those that have in the past been tried, tested and proven successful. Nowadays, every other technical analyst develops a new technical indicator or oscillator regularly. There are hundreds of oscillators available. In fact, you ‘will be confused as to which one would give you good signals. Our advice to you is to follow the tried and tested indicators. Also, keep in mind the following points:

  • Do not attempt to master all technical indicators and oscillators. Just pick up knowledge in about three of them.
  • Do not analyse stock’s price by applying just one indicator – use about 2 or 3 complementary indicators, as using just one indicator may give you a false signal. Using 2–3 indicators can confirm the signals given by one indicator, but if you get a different signal from another complementary indicator then you must not rush into the trade.
  • Take your time to study. With time you will develop the art of judging profitable trades using technical indicators. Do not expect to morph into an expert on day one and carry out trades based on a knee-jerk assessment. First put your new found knowledge to test and begin trading only if you’re proven correct most of the time.

You may like these posts:

  1. Introduction to technical indicators
  2. How does a technical indicator work ?

2 Responses to “Oscillators”

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deepak

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