Understanding and effectively utilizing an oscillator can significantly enhance your trading decisions. This guide will provide detailed instructions on how to use each feature of your oscillator and how to interpret its signals for effective trading.
The features of an oscillator provide key insights into market conditions. Below are the main features of the oscillator and their purpose.
These levels provide insights into whether an asset is potentially overbought (purchased excessively) or oversold (sold excessively). A trading asset is considered overbought when its price is thought to be higher than its "true" value, suggesting a possible downward correction. Conversely, an asset is viewed as oversold when it's lower than its "true" value, indicating a potential upward correction.
Regular divergence is a signal that the current market trend might end soon. A bullish divergence occurs when the price makes a new low, but the oscillator does not, indicating a potential upward reversal. A bearish divergence is when the price makes a new high, but the oscillator doesn't, signaling a potential downward reversal.
Hidden divergence, in contrast to regular divergence, suggests the continuation of the current trend. Bullish hidden divergence occurs when the price makes a higher low, but the oscillator makes a lower low, suggesting the continuation of an upward trend. Bearish hidden divergence is when the price makes a lower high, but the oscillator makes a higher high, indicating a continuation of the downward trend.
The MFI appears as small vertical lines in the middle of your oscillator. The higher the line, the stronger the trend. A rising MFI typically indicates that money is flowing into an asset, suggesting increased buying pressure. Conversely, a falling MFI suggests money is flowing out of an asset, indicating increased selling pressure.
Your oscillator comes with four alerts, helping you monitor and react to significant market events promptly. Below is a brief explanation of each alert. If you want to know how to setup your alerts, please read this guide.
A bullish cross alert is triggered when the oscillator line crosses above a specific level or another line, signaling potential buying opportunities.
A bearish cross alert is triggered when the oscillator line crosses below a specific level or another line, signaling potential selling opportunities.
A bullish divergence alert is triggered when the price reaches a new low while the oscillator fails to reach a new low. This could indicate that the downward trend is losing momentum and a possible trend reversal.
A bearish divergence alert is triggered when the price reaches a new high while the oscillator fails to reach a new high. This could suggest that the upward trend is losing strength and a possible trend reversal.
Accurate configuration of your oscillator parameters will significantly impact the accuracy of your trading signals. Let's explore these parameters in more detail.
The settings for the overbought/sold levels can alter the frequency and accuracy of the overbought and oversold signals.
The channel length is the number of periods the oscillator considers in its calculation. A longer channel length includes more data, which can smooth out fluctuations and reduce false signals, but may also delay the recognition of trend changes.
The average length is the period over which the moving average is calculated to smooth the oscillator. Increasing this length will smooth out the oscillator's movements, which can help filter out noise and reduce false signals but may also delay valid signals.
The MA length determines the number of periods used to calculate the moving average that creates the overbought and oversold levels. A longer MA length will result in less frequent overbought/oversold signals, while a shorter MA length will result in more frequent signals.
This is the threshold above which the asset is considered overbought. A higher overbought level will result in fewer overbought signals, and these signals will likely indicate more severe overbought conditions. Conversely, a lower overbought level will produce more frequent overbought signals.
This is the value below which the asset is considered oversold. A lower oversold level will result in fewer oversold signals, and these signals will likely indicate more severe oversold conditions. Conversely, a higher oversold level will produce more frequent oversold signals.
The parameters for the Money Flow Index can modify how sensitive the MFI is to price and volume changes.
The period refers to the number of periods used in the calculation of the Money Flow Index. A longer period will smooth out the MFI, reducing the frequency of overbought or oversold signals but may delay valid signals. Conversely, a shorter period will result in a more volatile MFI with more frequent overbought and oversold signals.
The multiplier impacts the sensitivity of the MFI. A higher multiplier increases the MFI's sensitivity, leading to more frequent overbought and oversold signals, and might result in more false signals. A lower multiplier reduces the MFI's sensitivity, resulting in fewer signals, but these signals may indicate more extreme overbought or oversold conditions.
Overbought and oversold levels in an oscillator provide insights into potential market reversals. When an asset's price exceeds the overbought level, it may indicate that the asset is being purchased excessively and might be due for a downward correction. Conversely, if the price drops below the oversold level, the asset might be undervalued, suggesting a potential upward price correction.
Regular divergence suggests an impending end to the current market trend. Bullish regular divergence indicates a potential upward reversal, while bearish regular divergence suggests a possible downward reversal. On the other hand, hidden divergence indicates a continuation of the current trend. Bullish hidden divergence suggests the continuation of an upward trend, while bearish hidden divergence indicates the ongoing downward trend.
The vertical lines in the MFI, found in the middle of the oscillator, represent the strength of a trend. The higher the line, the stronger the ongoing trend. A rising MFI indicates increased buying pressure as money flows into an asset, while a falling MFI indicates increased selling pressure, suggesting money is flowing out of the asset.
The 'Period' determines the number of periods used in calculating the MFI. A longer period provides a smoother MFI curve, reducing overbought or oversold signal frequency, while a shorter period leads to a more volatile MFI. The 'Multiplier' affects the MFI's sensitivity. A higher multiplier makes the MFI more sensitive to price and volume changes, resulting in more frequent signals, while a lower multiplier decreases sensitivity, producing fewer but possibly more significant signals.