Investing in the stock market can be an essential part of an investment portfolio. However, one must remember that it is also riskier than most other investment instruments. It is always best to have a diversified portfolio, though, and thus, most people invest in stocks and mutual funds.
Keeping that in mind, let’s look at one of the most critical technical analysis tools for profitable trading – oscillators.
What are oscillators?
Oscillators are indicators that help traders make decisions on when to buy or sell their stocks based on specific signals. Oscillators are typically used along with other charting techniques to make more accurate predictions.
Popular oscillators include MACD, RSI and Stochastic Oscillator. The use of multiple indicators helps increase the accuracy of forecasts by confirming trends as well as identifying patterns likely to form future trends.
Different market dynamics
Before looking into how oscillators work, it is important to understand what moves markets in general. Generally speaking, there are two major types of market dynamics: trending and sideways/ranging/gridlocked markets.
In trending markets, the price moves up or down steadily and consistently with few pauses along the way. In such markets, oscillators point to strong trends and give perfect entry and exit signals. A classic example of a trending market is any financial market after a widely publicized economic policy announcement, e.g., interest rates, trade figures etc.
Sideways, ranging or gridlocked markets
Sideways/ranging/gridlocked markets, on the other hand, occur when there are small alternating waves of upward movement and downward movement, which cancel each other out, leading to little change over time.
In such cases, it becomes difficult for traders to make money as they cannot continuously enter into long positions from short ones, nor can they exit their positions every time they run out of winners and losers. They cannot even hold on to their winning positions because the trend may reverse after a slight pullback leaving them in a loss position.
A way to make money in such markets is to go short when the price makes a low and enter long when it makes a high. It works because in ranging/gridlocked markets, there are more lows than highs and vice versa for up trending markets. In an upward-trending market, each low is higher than the previous one, which means that traders who went short at every low would have made good money over time, whereas those who went long only made losses. The opposite holds for down trending markets where each high is lower than the previous one.
Benefits of using oscillators
Thus, oscillators can trade in such markets by looking for divergences, i.e. when the price makes a high, but the oscillator makes a lower high and vice versa. The easiest way is to use two separate oscillators. One measures momentum like RSI, and another which measures trends like MACD or stochastic. When these indicators make crossovers, their direction provides strong entry and exit signals on every low/high, respectively. Suppose you do not get such clear signals. In that case, using both together will increase the accuracy of your forecasts significantly because there is no perfect indicator that works all the time.
For example, if an upward trend is strong, the trend indicator could still be rising even if the momentum indicator goes into negative territory. Similarly, if the momentum indicator is rising, but the trend is at a low ebb, it may indicate an uptrend that has not reached its peak or signalling danger ahead. Thus, oscillators are used to confirm buying and selling opportunities in trending markets and generate entry and exit signals in ranging ones.
Using oscillators will help increase the accuracy of forecasts by confirming trends. New investors are advised to use reputable online brokers Saxo Bank, to help them better understand market dynamics and oscillators. For the best forex trading advice, visit https://www.home.saxo/en-sg/products/forex.