Using trading oscillators
What are trading oscillators?
Oscillators are technical analysis tools ideal for markets that are range-bound and trading sideways. They can also be interpreted as indicators that fluctuate above and below a centerline as the price of an underlying asset fluctuates from high through low and vice versa. The most popular oscillator indicators include a stochastic indicator and Relative Strength Index.
Oscillators are normally used in conjunction with other indicators to make informed trading decisions. Technical analysts rely on oscillators to try and predict price movements when charts are not showing a definite trend in either direction.
Overbought and Oversold With Oscillators
Oscillators are also ideal trading indicators for identifying overbought and oversold territories as part of price action analysis. Most trading oscillators are measured on a percentage scale of 0 to 100, fluctuating between the high lows depending on price movements.
An overbought situation occurs when an oscillator indicator exceeds the 70 level, signifying a potential sell signal. Conversely, whenever the indicator moves below the 30% level, the same is interpreted as oversold, signaling a potential buy opportunity. Oscillators can remain in overbought or oversold territories for a prolonged period; they cannot trend for a sustained period.
Types of Oscillators
While there are different types of oscillators, the two broad categories are centered oscillators that fluctuate above and below a center point and banded oscillators that fluctuate between overbought and oversold territories.
The best for market situations where one needs to analyze the direction of price momentum. They are also ideal for identifying the strength or weaknesses of momentum. In most cases, security would be considered bullish whenever the oscillator is trading above the centerline and bearish whenever the indicator moves below the centerline.
On the other hand, are ideal when one wishes to identify overbought and oversold territories.
Relative Strength Index
Relative Strength Index is one of the most used banded oscillators that technical analysts use whenever a market is trading sideways with a lower range of 30 and upper range of 70. While below 30 and above 70 indicate oversold and overbought territories, some analysts consider the same as conservative as they might cause a trader to enter late, therefore, miss out on capital gains.
In the chart above, it is clear that whenever the RSI indicator dropped below the 30 level, Microsoft price immediately bounced back and started edging higher. The arrows in the chart indicate buying opportunities in this case.
Stochastic is another effective banded oscillator for identifying overbought and oversold situations. For stochastic indicators, a reading above 80 is considered overbought, while a reading below 20 is considered oversold.
However, it is important to note that security prices don’t always adhere to overbought and oversold situations. In this case, the price may continue to move lower even in oversold territories as well as up even when entrenched deep in overbought levels, as indicated by banded oscillator.
Oscillators, when used with other indicators, can help, a great deal, in identifying buy and sell signals. The indicators are also ideal for identifying overbought and oversold territories where one ought to stop trading awaiting a potential trend reversal.