Oscillators – Technical Analysis Tool
Oscillators are technical analysis tools that provide indications on the stock chart for determining overbought and oversold positions. RSI is a common oscillator used to carry out the same. When the stock is in an overbought state, the true value of the oscillator will be exposed which means that at that point the buying volume has been falling for days and traders will then start selling their shares. Similarly when the investors have exhausted their shares by selling for a long period of time will reach in an oversold position where the traders will initiate buying these shares. Overbought and oversold positions are simply saturation levels that hint the traders on when to sell and buy shares. Moving averages (EMA) is an indicator and not an oscillator and is crucial in learning the direction of the stock. Oscillators are employed when it’s difficult to predict the trend of the stock. Oscillators are measured on a percentage scale ranging from 0 to 100.
In RSI, it becomes oversold at 30 and overbought at 70 levels. Some traders do use 80 and 20 as overbought and oversold values respectively, but sometimes by using 80, they might actually miss out on the right selling entry point. The signal remains valid until the price of the stock continues fluctuating in the same price range. If a breakout occurs then these signals are no more valid as the price now has surpassed the range. During this breakout, the oscillator has a high probability of remaining in an overbought or oversold position for an extended period of time. RSI is best suited for range-bound or otherwise called a sideways market condition so that within a particular price range RSI signals can be effective. RSI oscillator can be combined with moving average lines for strong signals on entry points in a range-bound market condition. Investors and traders use oscillators as one of the most convenient tools to predict a trend or direction of the stock. Everything has its own pros and cons and so does oscillators. The major benefit of using oscillators in the stock market is that the trader can get early signals for entry and exit points. Thereby allowing traders not to miss out on any potential opportunities. In an uptrend market, the best use of an oscillator is to identify oversold conditions so that the trader can make a buy upon confirmation and vice versa with the overbought position. Early signals come with higher risk. Here, with early signals or even more frequent signals can lead to a series of false signals resulting in losses. The signals have to be carefully interpreted by the trader for making the right entry and exit points in the stock market.
Oscillators can remain at extreme levels, either an overbought or oversold position for extended periods, but they cannot trend for a sustained period. Some signals are geared towards the early entry, while others appear after the trend has begun. Most oscillators are momentum indicators and only reflect one characteristic of a security’s price action. Volume, price patterns, and support & resistance levels should also be taken into consideration. Divergence is a key concept behind many signals for oscillators as well as other indicators. It gives a warning in whether the trend is moving towards a fluctuation or to a buy or sells signal. Positive and negative divergences are the two variations where a negative divergence is when an indicator declines while the underlying security advances i.e when the security moves to a new high point the indicator fails to record the new high, forming a lower high. when the market is following a strong uptrend, negative divergence signals may not always be correct. A positive divergence is when the indicator advances while the underlying security declines. Here when the market moves to a new low but the indicator doesn’t record it forming a higher low. When its a strong downtrend, most of the positive divergence signals are not good.