What are Forex oscillators and what are they needed for?
Oscillators are often not mentioned as a separate group of instruments and are called indicators. Nevertheless, oscillators are not the same as indicators. In terms of technical analysis, an oscillator is an expression of price movement over a period of time. In a trading terminal, an oscillator is most often placed as a line chart at the bottom of the main chart. The oscillator should help the trader quickly and accurately show the trader the state of the market, in particular, to determine whether the market is overbought or oversold. Different trading platforms for Forex trading use more or less the same oscillators as the most popular and tested by time. On MetaTrader4 oscillators are located to the left of the chart in a special list (fig. 1).
Most other trading platforms use MetaTrader4 functionality. On the platform for binary options Binomo (website) there is also a standard set of oscillators (fig. 3): these are not highlighted in a separate list and can be found in the indicators section.
On the MetaTrader (4 and 5) platforms, apart from the standard ones, you can also download the author oscillators in the section Market by specifying the required search parameter (fig. 4).
The use of oscillators
It’s supposed that oscillators can predict the direction of trend change before it will be seen on the chart. The main thing that oscillators show and on the basis of what it’s possible to make market forecasts is overbought and oversold Forex markets (whole truth about Forex).
Overbought means when the price hits such a level when it’s not likely to keep rising. The state of oversold is characterized by a low price of the asset, which is why it’s most probably not going to get even lower. The state of being overbought or oversold means that the trend is going to change soon. The oscillator is meant to show overbought and oversold areas before the trend begins to change direction.
Oscillators are also used to detect divergences of the oscillator indices and price, and convergences of the oscillator indices and prices, which also indicate a change in trend. Most traders consider oscillators to be useless for a pronounced trend and effective for a flat, where with the help of oscillators you can quickly notice short-term oversold or overbought states. However, a different opinion exists: the oscillators can determine overbought and oversold in a period of a pronounced trend, and with the help of them you can see when the trend is losing strength.
Anyways, oscillators are most often used as a supplement to indicators rather than a complete trading tool. Indicators of oscillators reach their maximum precision in a number of cases: in particular, these include extremes that the oscillator reaches. This means that the trend is weakening and there may soon be a reversal. Another case that needs to be paid attention to is when the oscillator crosses the zero line and this coincides with the direction of the trend.
Classic oscillators in MetaTrader5
Let’s take a look at a few indicators that are pre-installed in the trading terminal MetaTrader5. Average True Range (fig. 5), or ATR indicator. The oscillator was invented by a famous trading theoretician and practician J. Welles Wilder. Av shows market volatility and can be used as a trend filter. It’s also considered the most effective in determining stop loss points.
The «True Range» itself is the largest product of three values intersection: the difference between the closing price of the previous period and the current minimum; the difference between the closing price of the previous period and the current maximum; the difference between the maximum and minimum at the present time. The ATR oscillator is nothing but a moving average of the true range values.
The principle of operation of the oscillator is based on the fact that the higher the oscillator value is, the greater the likelihood of a trend change will be, and thus, the lower, the weaker the trend, a flat movement prevails. In order for ATR to be used as a trend filter, a certain midline has to be set on the chart, determined approximately for each individual case. Strong trend movements are defined as a breakdown of this midline. The effectiveness of the indicator makes it popular in the development of advisers and automated trading systems aimed at determining the volatility.
The task of determining the balance of sellers (bears) or buyers (bulls) in the Forex market is solved through the use of indicators Bears Power and Bulls Power. Bears Power (fig. 6) is the difference between the minimum price per day and the exponential moving average with a period of 13. On the chart, the oscillator looks like a histogram with a zero level. If the oscillator values are below zero, bears dominate the market, while with the values being above zero, bulls take the initiative.
The strength of the bulls is shown by another indicator – Bulls Power (fig. 7). It represents the difference between the maximum price value and exponential moving average with a period of 13. On the chart it looks like a histogram with a zero level. If the values of the oscillator are above zero, then the bull dominates, if it is below zero, the trend may change in the opposite mood.
It’s advised to use oscillators Bears Power and Bulls Power combined with trend indicators, which will allow to determine market trends more accurately: for example, if the indicator shows an ascending trend and the bear index is below zero, then you should wait for the trend to change and you can open buy positions. And alternatively, if the trend indicator shows a descending trend and the Bulls Power is above zero, the near change of the oscillator readings may be assumed and the positions may be prepared for sale.
Chaikin Oscillator (fig. 8) predicts the changes of the accumulation/distribution line, that can allow to predict trend changes. The values of Chaikin Oscillator are calculated as the difference between the exponential moving averages for 3 and for 10 days. The positive value of the oscillator shows that bulls (buyers) are raising their pressure on the market; a negative value, respectively, shows that bears are becoming more active.
The indicator also shows a divergence, which allows to make more accurate prognosis of the trend movements. For example, on a descending trend, when a minimum below the previous one is taking shape, Chaikin oscillator shows a minimum higher than the previous one, it can be assumed that the bullish divergence is formed, the bears losing grounds. The oscillator is considered to be fairly accurate, but a little too sensitive, up until the point that the signal for opening positions, which is the oscillator crossing the zero line, takes place too often. Therefore, it is used along with indicators that allow to filter signals (for instance, RSI, CCI, Stochastic etc).
Commodity Channel Index (fig. 9) is a multifunctional oscillator Commodity Channel Index, CCI. It is mainly intended to determine whether there’s an overbought or oversold state, whether the price is overvalued or undervalued in respect to the average.
The oscillator has a scale on which values from +100% to -100% are indicated, showing, respectively, the undervalued or overvalued price values of oversold and overbought zones. High or low oscillator values show a possible correction or a trend change. In addition, the oscillator helps to determine good moments of entry or exit when crossing the zero line and shows divergences. However, the CCI is quite difficult to master.
The Demark oscillator, or DeMarker, or the Demark indicator (fig. 10) was invented by the analyst trader Thomas R. Demark, in order to accurately assess the state of overbought and oversold. Demark made a nice one, this oscillator is believed to be effective. Except of the overbought and oversold estimation, the DeMarker enables you to determine the divergence, the approximation of the trend reversal.
For example, if prices reach a maximum above the previous one, and the DeMarker shows a maximum below the previous one, then, most likely, the ascending trend will change to the descending trend. This position of the oscillator is called the «bullish divergence». The «bearish divergence» respectively shows the possible change of the descending trend on the ascending, when the price minimum is fixed below the previous one, and DeMarker shows the minimum above the previous one. Force index (fig. 11), or FRC, is an oscillator to determine the strength of bulls and bears on a descending trend or an ascending trend.
Force Index is made up of such indicators as the direction of price movement, the magnitude of price movement and the volume of trading. First of all, the current price and the previous closing price are compared. A total of three values allows to determine how strong the bulls are at the price rise or how strong the bears are at the price fall. If the current price closes above the previous one, then the force is positive, and the bulls dominate. If the current period price is less than the previous one, than the bears dominate, the strength is negative. One or another strength tendency gets confirmed by the trading volume.
The listed oscillators are among the hottest ones, like MACD, Momentum, Moving Average of Oscillator, Relative Strength Index, Relative Vigor Index, Stochastic, Zigzag, Fractals, Average Daily Range, Williams Percent Range, McClellan oscillator, Triple Exponential Average, Awesome Oscillator, Arms indicators and a set of others.
Benefits and drawbacks of oscillators
Different oscillators have different efficiency, are best suited for different situations, vary in complexity and other features that need to be studied before they get to be used in trading. However, the oscillators have both common drawbacks and advantages. The latter include, for example, the fact that they give advanced signals about the end of a trend or correction. Most oscillators are easily understandable and adjusted to the requirements of the trader. On the other hand, this being a drawback, these signals can appear to be false, and oscillators can, for example, signal a trend reversal even when a steady trend has formed.
This is why the oscillators are not used alone without indicators and their use is limited to the trading range equal to the length of the oscillator, after which they need to be readjusted.