A lot of traders no matter how experienced are they use oscillators. Oscillators may be found in a category of inductive statistics, math formulas are the foundation for this pattern. Forex trading is impossible to imagine without them, the list of oscillators’ functions is huge: they confirm market trends, under extreme conditions they can signal whether the trade is being oversold or overbought, show traders when the market is about to change due to loss of momentum. All these things make oscillators a vital part of technical analysis.
Rules for Oscillators Using
There are different types of oscillators, but the majority of them balances close to the baseline because they are set not near a price chart bottom. The baseline movement depends on the oscillator type and used math calculation. Usually, traders use the zero line with oscillators but there is a possibility of using 50 and 100 baselines instead.
Oscillators General Concepts
When the baseline is crossed by the oscillator there is a buy or sell signal. To increase the strength of the signal just add trend analysis to your oscillator. Because of that, it is necessary to combine the prevailing direction of the trend with signals were triggered by the baseline intersection.
Overbought or Oversold
As some oscillators have limits, they have not only the lower border but the upper too. The most common of them vary from 0 to 100, so the oscillators are on a range between 0 and a 100.
So, these limited types always come with overbought and oversold borders.
Mostly used by traders oversold and overbought bounds have 70/30 for RSI, 80/20 for Stochastics and 100/-100 for CCI.
Pay attention to the overbought level. There is a big risk in opening a new position when the oscillator is above the overbought level. It means that the price has been trading at ultra-high positions.
And the opposite situation: the oscillator is below the oversold level. What would you do? Yes, you are right. You will not open new positions because of the big risk, the prices are trading at ultra-low levels.
Usually, traders remember these rules and use them. But if there is a new trend on the establishment stage oscillators can quickly move into oversold or overbought positions to warn traders not to open new positions, both long and short. In such case, this rule can be neglected.
One more method offers us to analyze oscillators through divergence. It is widely used in a situation when oscillators are at maximum levels and trend has momentum. If there is a divergence between the oscillator and the price, a consolidation or a reversal is highly probable. It can be understood a signal that the trend is about to end soon. For example, when the price levels are at higher tops and higher bottoms while it is moving upwards, and oscillator does not show such levels it can be called as “negative divergence warning”. The meaning is that a downside reversal can happen.
But if we are talking about a downward track of the price and it forms tops and bottoms lower, while the oscillator has another position (not lower bottom) there is a “positive divergence”. It is a prediction of upside reversal.
In other words, divergence was created to warn traders at early stages. It can show little changes in the situations before some crucial reversal will occur. It seems like a dream for every trader but there are no guarantees and it is just a warning, you should always remember it. Traders should be patient and attentive to see the price reversal before new positions are opened.
To Sum Up
Most traders use oscillators. They can predict trend directions and signal about buy and sell opportunities, these functions make them valuable. Also, they prevent you from opening new positions when a trend is about to end and price levels are extreme. Oscillators have an ability to see possible reversal before it turns to the real one. Not to lose profits combine oscillators with price chart analysis.