Lesson 6: An Introduction to Technical Analysis

Market and Momentum Oscillators

Overview

  • A change in momentum is often a signal that the current trend is weakening. For this reason, traders need tools that can measure market momentum.
  • When it comes to trading one thing is certain; all prices will eventually reverse. The closer to the reversal point you can into into an appropriate positions, the greater your profit opportunity.
  • Keep in mind however, the earlier you act, the greater the chance that what you believe is a reversal, is in fact, only a fluctuation and you could find yourself on the wrong side of the trend.
  • A Momentum Oscillator can help you distinguish between reversals and fluctuations.


momentum oscillator
Momentum Oscillator
  • Oscillators work under the premise that as momentum begins to slow, fewer active buyers and sellers are willing to trade at the current price. Therefore:
    • In a rising bull market, slowing momentum could indicate that an upper resistance level has been reached, and after peaking, the price may be about to reverse.
    • In a falling bear market, slowing momentum could suggest that the price is near a support level and traders are looking to buy at a bargain, which could reverse the bear trend.

Because forex is an over-the-counter (OTC) market, it can be difficult to see an aggregated view of total orders and positions. Market and momentum market oscillators provide additional insight into market sentiment.

Stochastic Oscillator

  • The Stochastic Oscillator measures the strength of the current direction trend. It is based on the following assumptions:
    • As a market moves upwards, it will close at the upper end of the reporting period's range
    • As a market moves downwards, it will close at the bottom of the reporting period's range
  • An intra-period high indicates an over-bought position that the market failed to support, resulting in a price rate decline.
  • An intra-period low represents an over-sold position that triggered a buy response from market participants, ultimately sending the price to a higher closing price.
  • There are two basic stochastic types – fast stochastics and slow stochastics.
  • Fast stochastics are very sensitive to rate changes and are considered by some traders to be too volatile. Thus, slow stochastics are seen by some analysts as the more reliable indictor.


slow stochastic
Slow Stochastic Chart

As part of its policy of complete transparancy, OANDA offers utilities that show the sentiment of OANDA's traders. The Open Orders Summary shows all pending orders and the price points for triggering a new order as well as Stop Loss and Take Profit levels. The Open Positions Summary shows the entry point for all current open orders and can be used as an indicator of market reaction price changes.

Moving Average Convergence / Divergence (MACD)

  • The MACD Oscillator uses moving averages to look for trade signals generated when moving averages either converge or diverge from each other.
  • In order to see this effect, you must include at least one slow moving average, and one faster moving average.
  • For example, say you want to watch EUR/USD; you could create a MACD chart with two average price trend lines, one showing the average rates for the past three hours, the other showing rates for the past ten minutes.


macd
Sample MACD Chart
  • If the short-term moving average moves up and crosses over the longer-term average, this is a signal that the rate is trending upwards. The greater the deviation, the more pronounced the uptrend.
  • On the other hand, if the short-term moving average falls below the longer-term average, this is an indication that the rate is trending down. Again, the greater the deviation, the stronger the trend.

Relative Strength Index (RSI)

  • The Relative Strength Index (RSI) is another tool used to identify rate direction.
  • As the name implies, it measures the strength of the rate movement and is based on the concept that rates are generally "elastic" in nature, and can move only so far from the average rate.
  • In other words, the greater the strength of the trend, the further the price can move from the average. By quantifying the relative strength, the RSI provides insight into a trend's ability to "break away" from the average mean rate.
  • Typically, a rapid rate increase results in an overbought situation, while a rapid price decrease brings about an oversold situation.
  • Like other price charts, the RSI index forms price chart patterns (double tops, head and shoulders, etc.) in the same manner discussed earlier in this lesson.


relative strength index rsi
Relative Strength Index Chart

This is for general information purposes only - Examples shown are for illustrative purposes and may not reflect current prices from OANDA. It is not investment advice or an inducement to trade. Past history is not an indication of future performance.

Trading FX and/or CFDs on margin is high risk and not suitable for everyone. Losses can exceed investment.