All "bound" oscillators have upper and lower boundaries.
Which are called
"overbought" upper boundary
"oversold" lower boundary
- Definition: Overbought and oversold refer to the relative extreme levels reached by an asset's price.
- Indicators: Common indicators like the TMO, and the Relative Strength Index (RSI) and Stochastic Oscillator are examples of bound oscillators with overbought and oversold boundaries.
- Interpretation:
- Overbought: When an asset's price has risen and is now considered overvalued relative to its recent average. No entry is recommended if the oscillator is in the overbought zone.
- Oversold: When an asset's price has fallen and is considered undervalued to its recent average. No entry is recommended when the oscillator has fallen into this basement zone.
- The textbook entry zone is when the stock is above the oversold boundary but below the midpoint and is trending upwards.
There are three conditions to observe when using
Oscillators.
- Zero-crossing (Delta of Price): bullish when crossing above midpoint (the midpoint is 'usually' zero but can also be 50 or something else).
- Signal Line Crossing (Variance in Price): bullish when crossing from below to above the oscillator's moving average.
- Direction Change: bullish when below midpoint and starts ascending,
They are generally used together.
Direction Change Trading is the most traditional use of oscillators. Crossing above Oversold and Crossing below Overbought.
Zero-crossing is used to verify that the triggers from your other indicators now have momentum.
Signal-crossing, when oscillator crosses its average, is a sign that a change is a-coming but only works when not in chop.
(not to be used on the lowest timeframes due to lag).
No indicator can be used in isolation or on a single timeframe. Trend & momentum indicators require confirmation on higher timeframe.
You can stack the deck in your favor with correlation of trend to market indices.
The only way you will know which works best for you is to play with the settings and see how the oscillator lines up w/ your strategy and with your other indicators.
On a lower timeframe you might look for Zero-crossing and then
On a higher timeframe, confirm Signal-crossing.
To determine if an oscillator brings value and how you will trade it, analyze it over different timeframes, across history and with multiple instruments.
Pros: When a stock trends, all oscillators can provide significant profitable entry / exit zones.
Cons: When a stock is ranging, oscillators are rife with false signals.
The Catch: There is no way to know at time of trigger whether your instrument is going to range or trend so stop loss / portfolio management is the most important aspect of trading with oscillators.
Backtesting of Oscillators is not necessary. Results for all oscillators are approximately the same. They are highly successful when a trade trends and not successful when ranging. The use of multiple-times-frames is not assurance that a trade will trend or range. However, signals are more accurate on higher timeframes (less noise).
More reading:
https://thepatternsite.com/Oscillators.html
Success rates can be increased by the
addition of non-collinear studies