Oscillators work under the premise that as momentum begins to slow, fewer buyers (if in an uptrend) or fewer sellers (if in a downtrend) are willing to trade at the current price. A change in momentum is often a signal that the current trend is weakening. Let’s take a look at a couple of examples of oscillators and how to use oscillators correctly.
Oscillators are a class of technical indicators that measure momentum by comparing the current price to the price range over a given period. These are useful in range-bound markets because that’s when price highs and lows for a given period provide meaningful support/resistance and thus are indicators that a reversal is more likely when price approaches these limits.
The figure above is an example of a daily EURUSD chart with three of the more popular types of oscillators, Moving Average Convergence/Divergence (MACD) on top, Relative Strength Index (RSI) in the middle, and Stochastic Oscillator on the bottom.
As their name implies, they oscillate between extreme levels or around a center line. Extremely low readings indicate an exceptionally low price for a given period and theoretically oversold condition. Extreme high readings suggest the opposite. Again, this information is very useful in range-bound markets, but meaningless in strongly trending markets, when the highs and lows that the oscillators depict are obsolete.
There are many oscillators, and there is plenty of good material on their theory and use online if you just enter their names into your search engine of choice. Because our focus is more on providing material on the practice and theory of profiting from forex trading that you can’t easily find elsewhere, and because so many of the oscillators are similar, we’re going to keep this article brief and recommend that you do some further study of these oscillators so that you understand how they work, and include at least one of them as part of your usual toolbox of four to seven forex indicators.
Regarding the oscillators shown in the Figure above:
Oscillators generate buy/sell trading signals by showing:
Crossovers occur when price crosses an indicator, or two indicator lines cross, for example:
When the MACD histogram crosses under the (usually red) signal line, that’s bearish, suggesting further reversal lower. When it crosses above the (usually red) signal line, that’s bullish, signaling possible reversal higher. Again, see Figure above for examples, with bullish and bearish crosses highlighted and labeled.
Momentum oscillators generally move in the same direction as price. However, because the momentum oscillators are measuring not just the direction of price change but also the rate of change in price, their direction will diverge from the direction of the price of the asset when the rate of change slows. In other words, when the price is moving higher or lower, so should the oscillator. However, when the speed of that trend slows, the direction of the momentum oscillators will start to diverge from that of price. Those divergences can be valuable leading indicators of a possible trend reversal. For example, slowing momentum, as reflected by these divergences, suggests a trend reversal may becoming. (See Figure below)
Here’s some explanation.
We repeat: Oscillators are not that useful in strongly trending markets because prior highs or lows are not especially relevant. The perception of value is changing, hence the irrelevance of old highs and/or lows.
That said, in range-bound or gently trending markets they’re very useful in providing evidence of coming turns. The wider the trading range or channel, the lower the risk and the higher the potential yield. As we noted earlier when discussing channels, be wary of trading against the direction of the channel unless the channel is wide enough to allow you to profit even as time erodes your room to profit and pulls resistance closer each day.
There are many. First, do some more research on the ones we’ve mentioned. Not only are they as useful as any, they are also among the most popular and thus help you to understand what other traders are thinking and to anticipate their moves.
Here’s a partial list of other very popular oscillators you should certainly consider:
Understanding how to use oscillators correctly is important, but if you want some help, MetaTrader 5 AM Broker offers a useful Oscillators toolkit and our trainers can provide you the right guidance. Play around in a demo account and notice how oscillators can make you serious money. Alternative, use an Expert Advisor Builder and generate automated trading strategies using oscillators in a few clicks, without writing codes.