1-year special: Indexes and oscillatorsDear readers and TradingView, today, it has been one year since our first publication. Therefore, we would like to express our gratitude for your immense support. Additionally, we prepared an education topic on indexes and oscillators for you.
Indexes
Indexes are cumulative sums of data, like price, volume, etc., continuously measured over time. Indexes are not limited to the boundaries like oscillators are, showing absolute changes. The relationship between price trend and index trend is more relevant than the value of the index itself. Indexes' forecasting strength lies in spotting the divergence between price and index trends. Therefore, the use of indexes is suitable for analyzing trending markets.
Oscillators
Oscillators are limited to specific past periods, and unlike indexes, they tend to oscillate within certain boundaries. Although, oscillators without boundaries also exist. The opposing limits usually represent contrary conditions in the market. Therefore, an oscillator's value is relevant for technical analysis as it has interpretative meaning. As oscillators oscillate, they tend to reach upper and lower bound extremes, called overbought and oversold zones. These extremes are implied by the value of 70 for overbought and 30 for oversold conditions. Although, oscillators do not always have to reach extremes near their boundaries. The study of trendlines, channels and patterns is applicable to oscillators. In addition, oscillators can be used to spot the divergence between price trend and oscillator trend. Furthermore, oscillators can be used in both trending and non-trending markets. However, oscillators also tend to perform well in the trading range as they can indicate potential reversals.
Illustration 1.01
The picture above shows the daily chart of PepsiCo stock. Additionally, the chart shows the Relative Strength Index (RSI), which is probably one of the most famous momentum oscillators. The general area between 30 and 70 has a purple background. Absolute extremes below 30 and beyond 70 have a white background.
Overbought
Overbought is the market condition when it, or a security, is being expensive to its relative past time. On a graph, it is illustrated as an upper zone.
Oversold
Oversold is the condition of a market or particular security when it is being cheap to its relative past period. In other words, it is the opposite of the overbought condition. On a chart, it is depicted as the lower zone.
Overbought and oversold level readjustments
Overbought and oversold levels should be readjusted according to the strength of a prevalent trend. In an unusually strong uptrend, the overbought zone can be readjusted from 70 to 80 as the oscillator tends to peak at a higher value in such instances. Similarly, the oversold zone can be readjusted from 30 to 40 because an oscillator tends to bottom at a lower value in a strong uptrend. In a powerful downtrend, the overbought level can be readjusted from 70 to 60 as the oscillator tends to reverse sooner. Again similarly, the oversold level can be readjusted from 30 to 20 because an oscillator tends to bottom out at a lower value.
Illustration 1.02
Illustration 1.02 depicts the daily chart of American Airlines stock and 21-day Kaufman's Adaptive Moving Average.
Leading and lagging indicators
The latest era of advanced computerized technology allowed easy usage of indexes and oscillators. These tools are also often called indicators. Technical analysis differentiates between leading and lagging indicators. Leading indicators are observable variables that predict a change in another variable, like price, volatility, etc., with which they are correlated. Leading indicators are used for forecasting purposes. In contrast to leading indicators, lagging indicators exhibit change only after the change in another correlated variable has already occurred. In other words, they trail change in another variable with some latency. Therefore, lagging indicators are good to confirm the prevailing trend.
Divergence
When a trend is prevalent, and two indexes (or an index and price) are going simultaneously either up or down, they exhibit a positive correlation. However, when this correlation breaks and one index (or the price) keeps going up while another index reverses down, the divergence is said to occur. Technical analysts should pay attention to this instance as it can sometimes foreshadow an upcoming trend reversal. However, there are many instances when divergence occurs, and the reversal in price trend fails to materialize. For this reason, some analysts like to implement the concept of double divergence.
Illustration 1.03
The illustration above depicts the daily chart of Coca-Cola stock in a weekly time frame. The divergence between the direction of price movement and the RSI movement is observable.
Relationship between the price and the indicator
Technical tools are often used to predict the next move in price. However, there are instances when this relationship reverses and price starts to precede the movement of a particular indicator. This phenomenon is called reversal (not to be interchanged with the reversal in trend).
Crossover
Crossover occurs when the oscillator crosses over a significant level or crosses another oscillator. Important values are often represented by numbers such as 0, 30, 50, and 70. Other significant values can be either in the middle of the scale or near the boundaries of an oscillator. A trend is typically bullish when the oscillator moves above 0. When the oscillator moves below 0, it is generally considered to be bearish. Mechanical traders favor crossovers because they are easily observed, and their implementation helps avoid emotions that could potentially interfere with the trader's decision-making.
Illustration 1.04
The picture above shows the daily chart of Glencore stock and MACD. Bullish crossovers occurred when MACD passed through the midpoint indicated by the number 0. This was followed by the beginning of the rally.
Utility of indexes and oscillators
Technical tools such as indexes and oscillators can be used to analyze a large spectrum of assets. They apply to stocks, commodities, ETFs, futures, currencies, and even cryptocurrencies.
DISCLAIMER: This analysis is not intended to encourage any buying or selling of any particular securities. Furthermore, it should not serve as a basis for taking any trade action by an individual investor. Therefore, your own due diligence is highly advised before entering a trade.
