All Financial Wisdom
Forex Trading: The basic indicators to trade (and III)
To end with the series of articles focused on the various technical indicators that can help us in our Forex trading, and after having analyzed moving averages and the Bollinger bands and the MACD, it’s time to take a look at indicators with “Magic” properties: the oscillators .
An oscillator is nothing more than an indicator that graphically shows the current price situation in reference to its minimum and maximum over a certain period. Therefore, it is always included in a closed interval between 0 and 100%. Hence its name oscillator: the indicator is always drawing “mountains” within a predefined strip, indicating areas where the price is cheap (oversold, below 20% normally) or expensive (overbought, above 80% usually).
Basic Operation of Oscillators
The oscillators are considered indicators of momentum, that is, what they pretend to visualize is more speed than other aspects of the price. The advantage of following the price momentum lies in the general notion that momentum tends to give signs of a trend change before price does; a property that can provide warning signals in the face of possible price trend changes.
But the basic operation of the oscillators is much simpler than trying to detect trend changes. Since they indicate areas of overbought and oversold, oscillators are used to implement the winning strategy par excellence in any financial market: buy when the price is cheap and sell when it is expensive .
To do this, it is always necessary to buy when the oscillator is in the low oversold area (cheap price indication) and sell when the high overbought area is reached (price indication expensive). If the transaction is short in a downtrend, the exact opposite is done. Understandably, this technique can be further optimized to further adjust the buying and selling times and to better monetize operations.
Finally, it should be noted that oscillators are often extremely effective in showing divergences. Divergences are nothing more than disparities between the trend of the indicator itself and that of price. That is, when, for example, the price is making decreasing maxima while the indicator is increasing them. The price marks a bearish trend while the oscillator, the bullish mark. An oscillator with its well-configured parameters can anticipate price changes based on divergences. This phenomenon, combined with overbought and oversold areas, is a phenomenal aid in deciding the optimal time to enter the market.
Which oscillator do I use: stochastic, RSI? Does it matter?
There are many oscillator indicators, most notably the relative strength indicator (RSI). But in reality, it is not too important which of them to use whenever the parameters that characterize it are well defined.
In general, all the indicators must be adjusted to the market that is being traded, and the time scale in which it works, with the aim of achieving a sufficient number of signals to enter the market, without letting too many opportunities escape.
In the case of the oscillators, we must adjust the number of periods on the basis of which the oscillator is calculated. As a general rule, the oscillators are usually adjusted to 14 periods, but it is possible that for certain occasions you need a signal that is a bit faster than that as it could end up generating too many false signals.
Of course, as with all indicators, the signals they provide are far from definitive, and you always have to complete the reading of a particular market situation with price action and other indicators.