Window Oscillators and Overlay Indicators
new percentage change will be [($30/7) – $3.57]/($30/7) × 100% = 16.72%. This
illustrates that when dropping off large values and replacing them with smaller
values, the average will account for this change by making sudden up and down
moves, causing the moving average values to be more erratic. To reduce the impact
of the drop‐off effect, we could:■ (^) Select longer lookback periods
■ (^) Use more front‐weighted moving average based oscillators (e.g., exponential
or linear weighting)
8.5 Trend Trading Using Oscillators
We may use oscillators to time continuations and breakouts in the direction of the
existing trend. It is always best to trade in the direction of the larger existing trend.
To do this effectively using oscillators, we look for the following signals to join
and trade in the direction of the larger existing or predominant trend:■ (^) In an existing uptrend, a buy signal is represented as:
■ (^) Oscillator crossing above the equilibrium line
■ (^) Oscillator crossing above its signal line
■ (^) Oscillator is at oversold or rising back above oversold levels
■ (^) Oscillator displaying bullish standard or reverse divergence with price
■ (^) Oscillator violating a chart pattern or trendline to the upside
■ (^) In an existing downtrend, a sell signal is represented as:
■ (^) Oscillator crossing below the equilibrium line
■ (^) Oscillator crossing below its signal line
■ (^) Oscillator is at overbought or declining back below overbought levels
■ (^) Oscillator displaying bearish standard or reverse divergence with price
■ (^) Oscillator violating a chart pattern or trendline to the downside
8.6 Window Oscillators
We shall now turn our attention to a few popular indicators, such as MOM, ROC,
MACD, Stochastics, and so on. These oscillators are referred to as momentum
oscillators since they track the underlying acceleration and deceleration of price
action. Momentum tends to weaken and strengthen before price. It is this quality
that makes such oscillators effective in forecasting potential trend changes.
Unfortunately, momentum oscillators are not very useful during a strong and
prolonged up- or downtrend, as they tend to remain at overbought and oversold
for long periods. During such periods, it would be better to use price overlay
indicators such as support and resistance, trendlines, moving averages, channels,
envelopes, and volatility bands to signal any potential trend change. The use of
a trend change indicator such as the average directional index (ADX) may also
prove useful in gauging the beginning and end of a trend.
Finally, it is always best to fully master the use and interpretation of one oscil-
lator well instead of using multiple oscillators and not being entirely familiar with