Constructing an Oscillator Using Two Moving Averages
posted under
Philosophy of Technical Analysis
by ceecabolos
Chapter 9 discussed two moving averages being used to generate buy and sell signals. The crossing of the shorter average above or below the longer average registered buy and sell signals, respectively. It was mentioned at that time that these dual moving average combinations could also be used to construct oscillator charts. This can be done by plotting the difference between the two averages as a histogram. These histogram bars appear as a plus or minus value around a centered zero line. This type of oscillator has three uses:
1. To help spot divergences.
2. To help identify short term variations from the long term trend, when the shorter average moves too far above or below the longer average.
3. To pinpoint the crossings of the two moving averages, which occur when the oscillator crosses the zero line.
The shorter average is divided by the longer. In both cases, however, the shorter average oscillates around the longer average, which is in effect the zero line. If the shorter average is above the longer, the oscillator would be positive. A negative reading would be present if the shorter average were under the longer. (See Figures 10.5-10.7.)
When the two moving average lines move too far apart, a market extreme is created calling for a pause in the trend. (See Figure 10.6.) Very often, the trend remains stalled until the shorter average line moves back to the longer. When the
shorter line approaches the longer, a critical point is reached. In an uptrend, for example, the shorter line dips back to the longer average, but should bounce off it. This usually represents an ideal buying area. It's much like the testing of an up trendline. If the shorter average crosses below the longer average, however, a trend reversal In a downtrend, a rise in the shorter average to the longer usually represents an ideal selling area unless the longer line is crossed, in which case a trend reversal signal would be registered. The relationships between the two averages can be used, therefore, not only as an excellent trend-following system, but also to help identify short term overbought and oversold conditions.
1. To help spot divergences.
2. To help identify short term variations from the long term trend, when the shorter average moves too far above or below the longer average.
3. To pinpoint the crossings of the two moving averages, which occur when the oscillator crosses the zero line.
The shorter average is divided by the longer. In both cases, however, the shorter average oscillates around the longer average, which is in effect the zero line. If the shorter average is above the longer, the oscillator would be positive. A negative reading would be present if the shorter average were under the longer. (See Figures 10.5-10.7.)
When the two moving average lines move too far apart, a market extreme is created calling for a pause in the trend. (See Figure 10.6.) Very often, the trend remains stalled until the shorter average line moves back to the longer. When the
shorter line approaches the longer, a critical point is reached. In an uptrend, for example, the shorter line dips back to the longer average, but should bounce off it. This usually represents an ideal buying area. It's much like the testing of an up trendline. If the shorter average crosses below the longer average, however, a trend reversal In a downtrend, a rise in the shorter average to the longer usually represents an ideal selling area unless the longer line is crossed, in which case a trend reversal signal would be registered. The relationships between the two averages can be used, therefore, not only as an excellent trend-following system, but also to help identify short term overbought and oversold conditions.
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