Oscillator Indicators
Markets can generally be described as trending – that is, moving steadily in one direction with a series of higher highs and higher lows or a series of lower highs and lower lows – or non-trending – that is, trading within a sideways range or trading so erratically that they don’t fit any kind of definition for a trend.
Similarly, technical indicators can generally be placed into one of two main categories – those that are trend-following and those that are trend-fading. The trend-followers attempt to identify points where a trend begins or shows signs of continuing. The trend-fading indicators try to spot points where prices are likely to bounce back from some type of indicator boundary or threshold level.
The trend-followers tend not to have any limit on how high or low the indicator reading might be as values move on either side of a zero or neutral line whereas the trend-faders tend to fluctuate within a 0 to 100 (or vice versa) scale, usually within some prescribed parameters that are short of the extremes on the scale.
The trend-fading indicators are usually based on some measure of momentum value that suggests strength or weakness of a price move and, because they fluctuate back and forth within boundaries, are often known as oscillators. These oscillators work best in non-trending conditions, which account for much of a market’s time.
Oscillators tend to be most valuable when they move into extreme values that suggest overbought or oversold situations, when there is divergence between the oscillator and price action or when the oscillator crosses above or below a threshold or midpoint line.
Although the interpretation of the signals is pretty much the same for all of the momentum oscillators, these oscillators can be created a number of ways. Some of the best-known oscillators include:
Stochastics, which evaluates where the current close is relative to a recent price range.
Relative Strength Index (RSI), which judges market strength based on up closes vs. down closes.
Commodity Channel Index (CCI), which uses a moving average to calculate a normalized closing value.
Percent range or Williams %R, which puts a different twist on the stochastics indicator.
