How to use the Awesome Oscillator in Forex

Introduction to using the awesome oscillator

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The awesome oscillator is one of the most straightforward looking indicators that you can find. It somewhat resembles the MACD (Moving average convergence/divergence) indicator or its nearest cousin, the Accelerator/Decelerator oscillator.

Most of the trading articles focus on the signals generated by the awesome oscillator. Especially the buy and sell signals when the oscillator also called the AO moves up and down across the zero line.

However, there is more to the oscillator than just the simple signals. To take advantage of the awesome oscillator, you need to gain context.

As you will discover, the oscillator was not developed as an individual indicator. It is instead a part of indicators which all form what Bill Williams called, the Chaos Theory.

Bill Williams and Chaos Theory

The awesome oscillator is an indicator that was created by Bill Williams. The indicator was part of the Williams’ Chaos Theory which made use of trading psychology and the famous Chaos Theory.

Williams’ was a significant proponent of Chaos theory which finds its use in different fields spanning across science, economics, mathematics to name a few.

Chaos theory is a study of complex systems whose behavior is very sensitive to the smallest changes in the conditions. A simple way to put this is the Butterfly Effect. For the more curious minds, this short presentation is a good starting point to dive deeper into the Chaos Theory.

The gist of Williams’ Chaos theory was that traders lose because they limit themselves to the fundamental and technical analysis. This makes them lose focus on the real markets which are non-linear and dynamic.

Williams’ stressed the importance of trading psychology. In fact, according to Williams’ trading can be easy if you understand the market structure. To understand the market structure, Williams says that traders need to focus on the incoherent parts called dimensions.

The dimensions that Williams refers to include the following:

  • Space
  • Energy
  • Force
  • Energy/Force combination
  • Attractors

Of course, needless to say, Williams developed technical indicators for each of the above dimensions. Besides the awesome oscillator, other indicators are:

  • Fractals
  • Acceleration/Deceleration oscillator
  • Balance line
  • Alligator

In this series of articles, we focus on some of the technical indicators outlined by Williams.

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How does the awesome oscillator work?

The awesome oscillator is merely a histogram that is represented by rising and falling bars which move above and below the zero line. The histogram is based on the difference between a 34 period and a 5-period simple moving average.

To explain this in very simple terms, the AO measures the difference between the two moving averages.

Fig 1: Awesome oscillator
Fig 1: Awesome oscillator

In the first chart above, you can see the price with the awesome oscillator added.

If you look to the next chart, we add the 34 and 5-period simple moving average (hide the price lines to get a better comparison), and you will see how the AO gives a visual histogram representation of the moving averages.

Fig 2: Awesome oscillator compared to 5/34 SMA
Fig 2: Awesome oscillator compared to 5/34 SMA

An important point to note is that the AO takes the average of the mid-point price which is (H+L)/2.

What does the awesome oscillator depict?

What do you get when you measure the difference between two moving averages? Momentum! The awesome oscillator is a momentum indicator. When the histogram is above zero and starts to rise, it indicates that the momentum in price is strong.

When the same histogram, above the zero line, starts to plot red histograms that are decreasing in height, it indicates falling momentum.

Similarly, when the bars start to post more substantial declines below the zero line, it indicates that the momentum in the price decline is increasing.

If you look at the next chart, you can identify these levels of rising and falling momentum looking at price and comparing it to the awesome oscillator.

Fig 3: Rising and falling momentum
Fig 3: Rising and falling momentum

From the above chart, you can see that the awesome oscillator starts to rise when the short term moving average is above the long term moving average. The further the distance between the two moving averages in this uptrend, the larger the histogram rises.

Likewise, in a bearish trend, when the short term moving average is below the long term moving average and the distance between the two starts to grow, you can see the histogram making longer bars to the downside, below the zero line.

Awesome oscillator – The standard signals

There are a set of standard rules that govern the buy and sell decisions when using the awesome oscillator.

The zero-line crossing

When the awesome oscillator crosses the zero line from below, it indicates that the markets are in an uptrend. Likewise, when the awesome oscillator crosses the zero line from above, it suggests that the markets are in a downtrend.

While this might seem simple, when the markets are trending flat, you can see that the AO moves above and below the zero line multiple times. Trading such conditions can leave your positions at risk of being whipsawed.

Thus, the zero line crossing works best when the trend is strong. On closer observation, you will notice that the momentum builds up much before the zero line crossing happens.

The saucer signal

The saucer signal is another type of signal, but you need to analyze the AO’s histogram on a bar by bar basis.

The signal forms when the AO is above the zero line but changes the direction from falling to rising. What this means is that there was a temporary loss of momentum (leading to the AO histogram turning red and lower) and the momentum is starting to build up again.

This can be similar to how you would see price posting a correction before resuming the trend.

Fig 4: The Saucer Buy Signal Example
Fig 4: The Saucer Buy Signal Example

The next chart above shows a buy signal in action. You can see that the AO is above the zero line. As the red bars start to emerge, you can then see the rising green bar. This buy signal means that price is regaining the momentum. For the rest of time in this uptrend, you can see how price rallies strongly.

Fig 5: The Saucer Sell Signal
Fig 5: The Saucer Sell Signal

The next chart above shows a saucer sell signal in action. This is precisely the opposite of buy. The AO’s histogram must be below zero and the AO should indicator a brief spell of easing momentum followed by increasing red bars to the downside indicating rising momentum.

The twin peaks signal

The twin peaks signal is another versatile signal which requires you to analyze the price action and compare it to the AO on a bar by bar basis. In the twin peaks buy signal, the AO needs first to make a peak.

Following this, momentum should slow and then rise again. Only this time, the peak should be lower than the previous high. At the same time, the AO needs to form two identical bars of the same height with the last histogram turning red.

This signal indicates that the momentum has peaked and marked the start of a decline.

Fig 6: The AO Twin Peaks sell signal
Fig 6: The AO Twin Peaks sell signal
Fig 6: The AO Twin Peaks sell signal
Fig 6: The AO Twin Peaks sell signal

The Twin peaks buy signal is the exact opposite. First, the AO must make a new low. Following this, the next peak must be smaller than the first one, and there should be two identical bars (in red and green) with almost the same length.

The Awesome Oscillator – Conclusion

So far, we have outlined how the awesome oscillator works and how it is part of the Bill Williams’ Chaos Theory. We have illustrated how the AO can independently give the buy and sell signals.

In the next part, we look at some ways how you can incorporate the awesome oscillator alongside other technical indicators to trade both in the short term and the long run.

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