Saeed Ebrahimijam Fall Faculty of Business and Economics Department of Banking and Finance Doğu Akdeniz Üniversitesi FINA 417

 Interpreting oscillators  TYPES OF OSCILLATORS 2 Fundamental of Technical Analysis and Algorithmic Trading

 Oscillators serve many purposes, but they are primarily designed to give a clear picture of market action.  They are relatively easy to construct and interpret.  They can be used regardless of whether prices are moving up, down, or sideways.  Many other technical tools have diminished value when prices are moving sideways.  This lesson examines the three main types of oscillators and the methods used to interpret each. Fundamentals of Technical Analysis and Algorithmic Trading3

 Oscillators are typically constructed with lower and upper boundaries, such as –1 to 1 or 0 to 100. Oscillator readings range between the lower and upper boundaries.  Typically, peaks and lows in the oscillator correspond to peaks and lows in market prices. Fundamental of Technical Analysis and Algorithmic Trading4

 Crossing of the Midpoint Line  Divergence Analysis  Extreme Readings Fundamental of Technical Analysis and Algorithmic Trading5

 When the oscillator crosses the midpoint line, a signal is given that prices will move in the direction of the crossing.  If the oscillator moves up through the midpoint line, the signal is bullish.  If the oscillator declines through the midpoint line, it is considered to be a bearish sign for prices. Fundamental of Technical Analysis and Algorithmic Trading6

 The midpoint line is typically zero for oscillators that range from negative to positive numbers (i.e., –1 to 1).  For oscillators with lower and upper boundaries of 0 and 100, the midpoint line is 50. Fundamental of Technical Analysis and Algorithmic Trading7

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 When market prices make a high, correct themselves, and then make a new high, and at the same time, the oscillator makes a high, corrects, and then does not make a new high, a bearish divergence occurs. “This suggests that market prices are likely to go lower.” Fundamental of Technical Analysis and Algorithmic Trading9

 Similarly, when market prices make a low, correct themselves, and then make a new low, and the oscillator makes a corresponding low, corrects, and then does not reach a new low, a bullish divergence occurs. “The implication of a bullish divergence is that market prices are likely to rise.” Fundamental of Technical Analysis and Algorithmic Trading10

 Extreme high readings suggest an overbought condition and are, therefore, viewed as bearish.  Extreme low readings suggest that prices have reached an oversold condition that is bullish. Note that oscillators can remain at extreme readings for lengthy periods of time.  Thus it is best to recognize extreme readings as periods of market vulnerability* and not as specific buy and sell signals. Fundamental of Technical Analysis and Algorithmic Trading11 * Vulnerability means Sensitivity

There are three main types of oscillators:  Momentum oscillators  Rate of change oscillators (RCO)  Moving average oscillators Fundamental of Technical Analysis and Algorithmic Trading12

 Momentum measures the acceleration or deceleration of prices rather than actual price levels. A momentum oscillator is constructed to measure that speed or rate of change.  To create a momentum oscillator: - Subtract the closing period’s price for a certain number of periods ago from the current period’s closing price. - Do this each period and plot the amounts calculated. For example, a five-day momentum oscillator is the difference between the current day’s closing price and the closing price five days ago. Fundamental of Technical Analysis and Algorithmic Trading13

 Each day this positive or negative value is plotted around the zero line as illustrated in Figure 14-1 for the S&P 500 index.  Table 14-1 shows how the momentum oscillator reacts based on the price gains for the current period’s activity versus those for N periods ago. Note that N can be any number of periods one chooses.  One of the benefits of the momentum oscillator is that it leads price action at market turning points. It then flattens out while the current price trend is in effect. Fundamental of Technical Analysis and Algorithmic Trading14

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 Rate-of-change oscillators are simply momentum oscillators in percentage rather than point-change form.  They are constructed as the ratio of the current closing price to the price a certain number of periods ago. For example, a five-day rate-of-change oscillator is calculated by dividing the current day’s closing price by the closing price five days ago.  Often the calculated rate-of-change value is multiplied by 100 and shown in percentage terms. In such a case, the oscillator will fluctuate above and below the 100 level.  Figure 14-2 illustrates a five-day rate of change oscillator for the S&P 500 index. Fundamental of Technical Analysis and Algorithmic Trading17

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 A moving average oscillator is constructed by taking the difference between two moving averages of different lengths and plotting that difference.  The difference can be the point difference or percentage difference between the two moving averages. Fundamental of Technical Analysis and Algorithmic Trading19

1. Identify divergences. 2. Note significant deviations caused by the shorter-term moving average moving far away from the longer-term moving average. 3. To make moving average crossovers easy to see. When the oscillator crosses the zero line, the two moving averages have crossed each other. Fundamental of Technical Analysis and Algorithmic Trading20

 Let’s look at an example. Figure 14-3 shows an oscillator based on 10- and 50-day simple moving averages of the S&P 500 index.  Note that when the 10-day moving average is above the 50-day moving average, the oscillator is at a positive value.  On the other hand, when the 10-day moving average is below the 50-day moving average, the oscillator reading is negative. Fundamental of Technical Analysis and Algorithmic Trading21

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