Hello dear readers, I believe this article will be of
greater interest to those who want to learn technical analysis. The Forex market is a global market with participants from many countries around the
world, open 24 hours a day, 5 days a week. Here, it’s possible to achieve
significant gains with a small capital by trading a wide range of assets such
as currency pairs, commodities, stocks, and cryptocurrencies. However, first,
we need to learn the rules of the market and understand technical and fundamental analysis. There are many tools used in technical analysis that support our
profitable trades. One of those tools is the “Awesome Oscillator”, which
we will now discuss.
What is the Awesome Oscillator?
The “Chaos Theory”, developed by the famous American trader
Bill Williams, is an alternative source for understanding and analyzing the
complexity of financial markets. The Awesome Oscillator(AO) is a technical
indicator that emerged as a result of this chaos theory approach. The indicator
utilizes the difference between simple moving averages (SMA) to measure market
momentum and the strength of trends. Bill Williams adapted chaos theory and
psychology to the understanding and analysis of financial markets, asserting
that price movements are not random but follow specific patterns and behaviors.
This approach has led to the utilization of the Awesome Oscillator as a tool
for deeper comprehension and evaluation of market movements. As evident, we can
say that the Awesome Oscillator is a product of integrating Bill Williams’ chaos theory approach into the analysis of financial markets.
How is the Awesome Oscillator formed?
The Awesome Oscillator is based on the divergence of simple
moving averages (SMA) and employs two different moving averages. These are a 34-period
SMA and a 5-period SMA. An indicator is obtained by calculating the difference
between these two moving averages. Calculating the Awesome Oscillator is quite
simple and involves the following steps:
- First, calculate the average of the closing prices for the last 5 periods. {5-period Simple Moving Average (SMA5)}
- Then, calculate the average of the closing prices for the last 34 periods. {34-period Simple Moving Average (SMA34)}
- Finally, subtract the value of SMA5 from the value of SMA34. In other words, calculate SMA5 - SMA34. Calculation of the Awesome Oscillator (AO):
AO = SMA5 - SMA34
The obtained value is presented as a histogram, representing
the result of the Awesome Oscillator. The upward or downward movement of the
histogram assists in showing the strength of price movements. This calculation
method forms the foundation of the Awesome Oscillator and is used to evaluate
market momentum. In situations where the indicator generates positive values,
it is generally thought that there is upward momentum. Conversely, negative
values indicate downward momentum. Analyzing the Awesome Oscillator supports a
better understanding of market movements, particularly how the histogram moves
above or below the zero line, providing more information about the strength of
market movements.
The Structure of the Awesome Oscillator
The indicator has a two-part structure.
Zero Line. Positioned at the center of the histogram,
the zero line provides us with a reference point to examine the upward or
downward movement of the histogram.
Moving Average Crossover Section (Histogram). This is
a histogram that represents the difference between the 5-period SMA and the
34-period SMA. The upward or downward movement of the histogram indicates the
strength of the trend. The bars in the histogram represent two fundamental
conditions:
Positive Bars (Green or Blue). Bars in the histogram
that move upward and are typically represented in green (or blue) or another
bright color indicate situations where the 5-period SMA crosses above the
34-period SMA in an upward direction. This signifies that short-term momentum
has surpassed long-term momentum, implying that the uptrend may strengthen.
Negative Bars (Red or Other). Bars that move downward
in the histogram and are usually represented with a dark color such as red,
reflect situations where the 5-period SMA crosses below the 34-period SMA. This
indicates that short-term momentum has been surpassed downward by long-term
momentum, suggesting that the downtrend could strengthen.
The size and direction of the histogram bars convey to us
the strength of momentum and the perspective of the trend. Large and long
positive bars indicate an increase and strengthening of upward momentum, while
similarly, large and long negative bars reflect an increase and strengthening
of downward momentum.
How to trade using the Awesome Oscillator?
We use the Awesome Oscillator to trade in the market by
analyzing the histogram and moving average crossovers. As mentioned earlier,
positive histograms indicate upward momentum, while negative histograms
indicate downward momentum, and moving average crossovers signify changing momentum.
When the indicator transitions from below the zero line to above it, it
provides a significant “Buy” signal. Conversely, when it transitions
from above the zero line to below it, it generates a “Sell” signal. Take
a look at the example on the Bitcoin/USD chart below for illustration.
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| Awesome Oscillator in the BTC/USD chart |
If the green bars in the histogram are increasing and
momentum is strengthening, it reveals that the uptrend is gaining strength and
indicates a possible buying opportunity. When the price chart is forming a
bottom while the green bars in the histogram show an upward movement, this is
referred to as a positive divergence. During this time, we can place a Buy
order. See the example Australian Dollar/US Dollar chart.
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| Positive(Bullish) Divergence on the Awesome Oscillator(AO) |
If the red bars in the histogram are increasing and momentum
is strengthening, it indicates that the downtrend is gaining strength and
presents a selling opportunity. If the price chart is forming a peak while the
red bars in the histogram show an upward movement, this is referred to as a
bearish divergence. During this time, we can place a Sell order. See the
example Euro/Australian Dollar chart.
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| Negative(Bearish) Divergence on the Awesome Oscillator(AO) |
Remember. As a part of technical analysis, the
Awesome Oscillator is one of the indicators that guides us in deciphering the
complex price movements in the market. As I mentioned in previous articles,
every single indicator can generate false signals, including the Awesome
Oscillator, which is the subject of this article. We should remember that
relying solely on one indicator may carry more risk than anticipated, and we
shouldn’t overlook the factor of risk. Happy trading!