Understanding the Difference between Oscillators and Momentum Indicators

Online Trading: Oscillators vs Momentum Indicators

There are two large categories of indicators in technical analysis and these are oscillators, also known as leading indicators, and momentum indicators, which are lagging indicators. Leading indicators are used to identify entry points before a new trend takes place while lagging indicators give entry signals after the trend has begun.

It may seem, initially, that oscillators will take your online trading into the stratosphere because, after all, they give you the signal before a trend even begins. However, the problem is that these indicators aren’t right every time because the market doesn’t always behave according to a logical, mathematical formula. There are many variables besides logic that affect price movement which is why oscillators often provide false signals.

One the other hand, lagging indicators give the signal to enter a trade only after the formation of a new trend has been clearly confirmed. While this might result in a lower profit, because you will be getting in on the trend a little late, the advantage is that you will have more profitable trades overall.

Online Trading: Common Oscillators

The simplest explanation of an oscillator is data that moves between two points, something like a pendulum. Trading signals are given off when data reaches one extreme or the other, but remember that the signals are not always accurate, which is why using oscillators alone isn’t a good approach to online trading. Well, at least not if you want to be profitable. Some common oscillators include the Relative Strength Index, Parabolic SAR and Stochastics.

The Relative Strength Index is a measurement of the power of sellers versus buyers in the market. In other words, RSI will tell you when the market is overbought, or when buyers have run out of steam, or when it is oversold. It is plotted as a line on a graph, below your chart, with a vertical axis between 0 and 100. When the line is below 30, the market is considered oversold and the result is a buying signal, and when the line is above 70, the market is overbought. So, essentially, RSI is an oscillator that signals the possible beginning of a new trend.

On the other hand, the Parabolic SAR signals the potential end of a trend, which is just as valuable because if a trend is ending, then the obvious next step is for a new trend to being. The Parabolic SAR (Stop and Reversal) plots points on a chart signaling possible trend reversals. So, when the points are below the candles, this is a signal to buy and when they are above then you should consider selling. However, the Parabolic SAR isn’t effective in volatile markets and is best used when the market is in a clear trend with long movements up or down.

Online Trading: Common Momentum Indicators

As previously stated, a momentum indicator will give a signal to enter a trade only after a trend has been confirmed. While this may result in lost profit, because the biggest movements in price are right when a trend begins, the advantage is that your overall rate of profitable trades will increase. One common momentum indicator is the MACD or Moving Average Convergence Divergence.

The MACD is plotted on its own chart with two lines representing the difference between two moving averages and a histogram. The histogram plots the difference between the slow moving average and fast moving average. All you need to remember with the MACD is when the two lines cross and one begins to veer away from the other, this is a signal that a new trend has formed.

Online Trading: The Toolbox

In online trading, your best option is to use both leading and lagging indicators to increase your chance of being profitable. For example, you could use the Parabolic SAR to signal the end of a trend and the MACD to confirm that a new one has begun. While your profit per trade might be a lot lower, the number of profitable trades you make will be much higher. After all, online trading isn’t a contest and your main goal should be to make a profit, even if you need to place more trades to reach your goal.

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