A good Forex trader looks for Forex market trends before placing a trade. There are several tools available that can help the Forex trader ‘understand’ these trends. An oscillator is one such tool.
An oscillator is a technical analysis indicator that is banded between two extreme values. Oscillators can be employed in different ways and for varied purposes.
Oscillators are primarily used as leading indicators as they inform us of a possible start of a new trend or its reversal. It is important to watch the current reading of the oscillator which usually describes the current strength of the trend, as well as the trend the oscillator’s values are following. If the values are rising, it indicates that the trend is gaining momentum and prices are changing faster. Conversely, if an oscillator’s values are decreasing, prices are changing at a slower pace and trend is losing strength, which can imply its reversal in the near future.
Forex Market Trends
A stochastic oscillator is often used when watching Forex market trends as it compares a security’s closing price to its price range over a given time period. The direction of an oscillator’s movement generally provides an indication of the direction of the underlying Forex market trend and a reversal in the direction of an oscillator suggests a reversal in the underlying Forex market trend. For example, an oscillator which is rising is generally regarded as bullish, as long as the oscillator doesn’t rise so high that it is in overbought territory. If the oscillator does rise into high territory, begins to slow down and finally turns downward, then the contract is giving an indication that it is losing upside momentum and that the short-term trend may be turning bearish.
Oscillators are also used to identify overbought and oversold conditions by watching their absolute value in the market. For example, if the price is rising too quickly, the oscillator reaches a level which indicates that the market is considered overbought. The price is rising too quickly at this level compared to the previous periods indicating a probable steep rise to be followed by a short-term price correction or a loss of momentum in the trend that will curb the price rise for an extended period. Conversely, if the oscillator reaches an oversold level, it implies that price is falling too quickly and it is plausible that the decline will ease or stop completely for some time. Oftentimes, this can be followed by a trend reversal.
Another way how to use oscillators is trying to find deviations between the indicator and market price or volume. For example, if the market price reaches the next high and it is higher than the previous high, while the MACD oscillator stops its rise at a level that is lower than the previous high, there is a bearish deviation in the market. This implies that prices are rising slower than in earlier periods and the trend is “running out of steam”. Such divergence usually precedes the start of a downward trend.