Oscillators

Oscillators are among the most valuable tools available to technical analysts, but they are also among the most misunderstood and misused. The trend of a market is the general direction of its price fluctuations-up, down, or sideways. A market's momentum is its rate of acceleration or deceleration. An oscillator is a mathematically derived measure of a market's momentum. As early as the 1920's, technical analysts were creating oscillators to measure a market's momentum rather than limiting their efforts to determining the market's trend.

In any trend, prices are gaining, maintaining, or losing momentum. A loss of momentum in an uptrend or a downtrend-prices rising or falling at a diminishing rate is an early warning sign that the trend might change soon. Therefore, when an oscillator shows that an uptrend is losing momentum, it is a cautionary signal that the uptrend may stall with prices either trading sideways or reversing into a downtrend. Similarly, when an oscillator indicates a loss of momentum in a downtrend, it may foreshadow a potential end to the downtrend.

Moving Average Convergence-Divergence

MACD, which was developed by Gerald Appel, is one of the most interesting and dependable technical indicators. It integrates positive features of both oscillators and trend-following indicators the result is an indicator that can measure a market's momentum without losing its capability to also follow a trend. In contrast to other well-known oscillators (such as RSI and stochastics), MACD is not limited to oscillating between fixed upper and lower extremes. It will continue to make new highs or new lows along with prices, as long as the trend is gaining momentum. In that respect, MACD also behaves as a trend following indicator., in the respect that it measure the rate of acceleration or deceleration between two moving averages to determine if a market is gaining or losing momentum, the MACD behaves as an oscillator.

The MACD consists of two lines that are derived from three exponential moving averages (EMA). The MACD line is the difference between a 12-period EMA and a 26-period EMA; the signal line is a 9-period EMA of the MACD line. The basic method for trading with MACD is to buy when the MACD line crosses above the signal line and to sell when the MACD line crosses below the signal line. However, entering and exiting trades based solely on MACD line-signal line crossovers results in frequent whipsaw losses. To make the best use of MACD, it is advisable to wait for crossovers that are preceded buy divergence and confirmed by the subsequent price action of the market. Figure 12 of May '00 Corn gives an illustration of MACD divergence that resulted in an excellent buy signal.