Generating Entries With Oscillators

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There are many ways to generate entry signals using oscillators. In this chapter, three are discussed.

One popular means of generating entry signals is to treat the oscillator as an overbought/oversold indicator. A buy is signaled when the oscillator moves below some threshold, into oversold territory, and then crosses back above that threshold. A sell is signaled when the oscillator moves above another threshold, into overbought territory, and then crosses below that threshold. There are traditional thresholds that can used for the various oscillators.

A second way oscillators are sometimes used to generate signals is with a so-called signal line, which is usually a moving average of the oscillator. Signals to take long or short positions are issued when the oscillator crosses above or below (respectively) the signal line. The trader can use these signals on their own in a reversal system or make use of additional, independent exit rules.

Another common approach is to look for price/oscillator divergences, as described by McWhorter (1994). Divergence is when prices form a lower low while the oscillator forms a higher low (suggesting a buy), or when prices form a higher high while the oscillator forms a lower high (suggesting a loss of momentum and a possible sell). Divergence is sometimes easy to see subjectively, but almost always difficult to detect accurately using simple roles in a program. Generating signals mechanically for a divergence model requires algorithmic pattern recognition, making the correct implementation of such models rather complex and, therefore, difficult to test. Generating such signals can be done, however;

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