How to trade with an oscillator

[Smart_trade]

Oscillators such as Stochastics,RSI,ROC are important tools in the hands of a trader trading on technical analysis. But oscillators are generally used in a wrong way and the common reaction of traders is to sell if the oscillator goes into overbought zone and buy once it moves in oversold zone.

The above is too simplistic way of trading with an oscillator....here we will discuss some nonconventional ways.....

Best wishes for the " Oscillating Roller Coaster Journey"

Smart_trade

 

[Smart_trade]

I would like to share an important phenomenon regarding oscillator overbought/oversold conditions. Whenever an oscillator like Stochastics,( or even RSI,ROC etc ) stays above the overbought limit for more than 5 bars without taking a dip from overbought to neutral zone....the market has a lot of steam left further to go up, market then continues upward journey,then comes down,then goes into overbought zone again but shows negative divergence and then only it comes down...till then it keeps making higher tops. This is a very strong bullish signal to trade.....

Mirror image for oscillator staying in oversold region for more than 5 bars...

The above phenomenon was what was happening towards the later part of the session yesterday (26-06-09).... I traded this observation yesterday and thought I will share with all....


Smart_trade

 

[Smart_trade]

I am posting Bank nifty fut 5 min chart of 26-06-09 which is used for day trading.....the top panel is a stochastic oscillator....I have marked 80 and above as overbought zone

The market goes from overbought to oversold and so on so forth in a trading or sideways market environment...so selling in overbought and buying in oversold zone is a good strategy....but somewhere markets start trending and that is where the trouble starts for our oscillator trader.

Observe in the chart that when market stays in overbought region for more than 5 bars ...it is extremely overbought and selling it is incorrect....market needs to dissipate this overbought reading and till then it will blast off on the upside and our oscillator trader will keep on selling in a market which is blasting off ....The correct action here is BUY....not sell...

Smart_trade

 

[ag_fx]

I would like to share an important phenomenon regarding oscillator overbought/oversold conditions. Whenever an oscillator like Stochastics,( or even RSI,ROC etc ) stays above the overbought limit for more than 5 bars without taking a dip from overbought to neutral zone....the market has a lot of steam left further to go up, market then continues upward journey,then comes down,then goes into overbought zone again but shows negative divergence and then only it comes down...till then it keeps making higher tops. This is a very strong bullish signal to trade.....

Mirror image for oscillator staying in oversold region for more than 5 bars...

The above phenomenon was what was happening towards the later part of the session yesterday (26-06-09).... I traded this observation yesterday and thought I will share with all....


Smart_trade

ST sir,

I have a question here. Oscillators like Stoch has 2 lines. One fast moving K and another slow moving D.Usually it will happen that the fast line will cross into overbot zone before the slow one does. Usually, a lag of 2-3 candles will take place.
So, for counting 5 bars, what should we consider? When should our counting begin? When both the slow and fast have crossed over into overbot/obversold zone or when the fast moving indicator crosses?

Thanks

Happy Trading

 

[Smart_trade]

ST sir,

I have a question here. Oscillators like Stoch has 2 lines. One fast moving K and another slow moving D.Usually it will happen that the fast line will cross into overbot zone before the slow one does. Usually, a lag of 2-3 candles will take place.
So, for counting 5 bars, what should we consider? When should our counting begin? When both the slow and fast have crossed over into overbot/obversold zone or when the fast moving indicator crosses?

Thanks

Happy Trading

Slow line is basically the moving average of the fast line...done for smoothing...so if you are a very aggressive trader...start counting from fast line...if you are a bit relaxed type...start counting from slow line...the aggressive trader counting on fast line will have more trades,early entries but also more whipsaws.....part of the game we are in....

Smart_trade

 

[manojkch]

Wow... ST Sir! Another Gem from you.:thumb: Thanks a lot for sharing your great observation :clapping:

When I just started in looking / studying TA, this question was unanswered to me that when the momentum indicator goes in overbought or oversold zone and market is strongly trending, then it remains in respective zone for more time. So I was having the confusion of how to take signal for buy and sell. Because as you rightly pointed out, in strong trending market, we get whipsaw in following momentum indicator and we miss the great move.

Now you have shown a very good way / direction how to trade the momentum indicator in overbought and oversold zone. Great observation:thumb:

Just one doubt... How to identify when to sell ( taking above example of BankNifty) when bought in overbought zone. For ex : 2.00 Pm candle was bearish ( engulfing ) and indicator also crossed 80 line from above to downside. So shall we take this indication to sell ? or should combine some other indicators to look for liquidating position ?

Also I want to know what will be the exact buying point ( ex : overbought condition) that is after completion of 5 candle in overbought zone, we should buy over high of 5th candle or Over latest bar high or latest PH( in these 5 candles) ?

Hope I am able to explain what I mean.

Thanks and regards
Manoj

 

[Rajadhiraj]

Wow... ST Sir! Another Gem from you.:thumb: Thanks a lot for sharing your great observation


Just one doubt... How to identify when to sell

Also I want to know what will be the exact buying point


Hope I am able to explain what I mean.

Nice, :clap:

"Exact Points" for "When to Buy" n "When to Sell", would make it a complete trading system and while we are at it why not add a bit on Money Management

:clapping: Looking forward to that, one more thread to track :clapping:

 

[MaxX]

Nice article ST

@manojkch, as ST said, in such a strongly trending day, one should look to only buy and not sell.. In his example the day closed at high of day, selling anywhere would have been a loss.

 

[manojkch]

Nice article ST

@manojkch, as ST said, in such a strongly trending day, one should look to only buy and not sell.. In his example the day closed at high of day, selling anywhere would have been a loss.

What I mean by sell in above example is when to book profit when bought. ( Quote : How to identify when to sell ( taking above example of BankNifty) when bought in overbought zone. For ex : 2.00 Pm candle was bearish ( engulfing ) and indicator also crossed 80 line from above to downside. So shall we take this indication to sell ? or should combine some other indicators to look for liquidating position ?)

Thanks for your kind advice

Manoj

 

[Smart_trade]

To understand the correct way of trading on oscillators let us study the Nifty futures 60 min chart. The stochastic oscillator is doing a great job till May 09end...calling each top and bottoms and our oscillator trader is on a high and feels that he has figured out everything in the markets and he is on his way to top the next batch of Market Wizards......But market has its own ways...we all know that....:lol:All of us have been there....

The problem areas for the oscillator trader are as under :

1) Up trending market from 27-5-09 ,1:00 bar to 2-6-09 ,11:00 bar

2) Up trending market from 9-6-09 ,3:00 bar to 12-6-09 ,12:00 bar

3) Down trending market from 12-6-09 ,3:30 bar to 16-06-09,12:00 bar

4) Down trending market from 17-06-09 ,3;00 bar to 18-06-09 ,3:30 bar

If he can handle the above 4 markets successfully,our oscillator trader is the king....

Let us see how he can handle these periods...I will explain first two cases,rest 2 are mirror images...

1) 27-05-09 ,1:00 bar onwards.....

On 27-5-09 at 1:00 bar the stochastic oscillator goes into overbought zone and that is a mouth watering trade for our trader friend to go short ( most will trade like this and repent later ). He goes short and gets killed in the subsequent market acyion.

The Oscillator Entry Qualifiers For Short Tradeare as under :

1) The oscillator should have gone to overbought zone.
2) Wait for a bar where the oscillator flips...ie comes out of overbought zone and comes in neutral zone....
3) In doing step No 2 the oscillator should not have stayed in overbought zone for 5 bars and more
4) Wait for a downclose ( meaning close less than earlier day's close)
5) Ensure that by that time oscillator does not go very near oversold region
6) Sell when the low of the downclose bar is broken on downside.....

If you observe all 6 qualifiers you will see that there was no shorselling opportunity in this uptrend.....our trader friend is home safely....and made money in longs....

2) 9-6-09 ,3:00 Bar onwards

Oscillator went into overbought territory and stayed there for 9 bars.....so no shortselling ideas to be entertained....

Here the market will move to neutral zone,dissipate the extra bullish pressure ,then go to overbought region,fulfill all 6 qualifiers,give negative divergence and then change its direction to down...let us see what it did...

Come to 12-06-09 ,12:00 bar...after dipping into neutral territory the oscillator has gone to overbought zone again....it stayed there only for 1 bar.....next bar 1:00 it dips again into neutral zone,gives a downclose...Now all qualifiers satisfied...the low of the 1:00 bar cracked in 12-6-09 , 3:00 bar and that is an ideal sell entry....mkt never looked up after thatAlso note the classic negative divergence here,the mkt making new higher top oscillator making lower top....all perfect...

The other two are mirror images in downtrend.Our friends can easily figure them out well .....

Best wishes....

Smart_trade