Introduction
Technical Indicators are primarily used to confirm a price movement and the quality of a candlestick pattern, and also to create trading signals with them. Indicators are a great source of strength to confirm an existing analysis. Moreover, some indicators solely help in analyzing the trend, momentum, and volatility of the market.
As discussed previously discussed, there are two types of indicators, leading and lagging. And oscillators fall under the leading indicators. That is, they determine the trend of the market before-hand.
Indicator construction
There are two ways through which indicators are designed:
- Non-bounded
- Oscillators
Non-bounded, as the name suggests, they are the indicators that are not bound in a specific range. They usually display the strength and weaknesses, and to an extent, generates buy and sell signals.
Oscillators, on the other hand, are indicators that are bound within a range. For example, 0-100 is the range they oscillate between. However, based on the type of oscillator, the range varies.
Oscillators
Oscillators are technical indicators that are mainly used to determine the oversold and overbought conditions. These non-trending indicators are used when the market is not showing any certain trend in either direction. They are unlike the moving averages (MA), which determine the trend and overall direction of the market.
When security is under an overbought or oversold situation, the oscillators show its real value. It indicates that one of the parties is losing its strength, and the other is slowly starting to gain together.
Interpreting Oscillators
Oscillators are constructed with lower and upper bounds. And these bounds form a range. In the below oscillator, the purple region represents range-bound, where 30 is the lower bound, and 70 is the upper bound. The upper and lower bounds are also referred to as peaks and troughs. Typically, the peaks and troughs in the oscillator correspond to the peaks and troughs in the market as well.
Extreme Regions
The oversold and overbought regions are the extreme regions. That is, when the oscillator line shoots above the upper bound, the market is considered to be overbought. On the contrary, if the oscillator falls beneath the lower bound, the market is said to be overbought.
An overbought market means that the buying volume has diminished over a few trading days. So, there could be a possibility for investors to sell their positions. However, note that this interpretation holds true when the market was in a predominant uptrend and is currently consolidating.
An oversold market indicates that the selling volume, which was high in the past days, has now diminished. This could mean that the sellers are done selling with the security and might begin closing their positions. Hence, indicating a turn-around in the market.
Midpoint Line
A crossover at midpoint region of the range depicts the gain in strength of the buyer or sellers. From the oscillator given, 50 is the midpoint line. So, if the oscillators cross above the 50 mark, it indicates bullishness in the market. And if cuts below 50, it could indicate bearishness in the market.
This concludes the lesson oscillators. In the coming lessons, we shall discuss some strategies using a few oscillators. Stay tuned. Happy trading!
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