Introduction
If you are interested in technical analysis and trading strategies, you might have heard of the Awesome Oscillator (AO). This indicator was created by Bill Williams, an acclaimed trader and author of several trading books on trading psychology, and who has also created the Alligator Indicator and the Gator Oscillator.
The Awesome Oscillator is designed to measure market momentum, identify momentum shifts, and help traders identify trends and reversals. In this article, we will see what the Awesome Oscillator is, how it works, and how to use it in trading.
The Awesome Oscillator is actually a histogram that displays the difference between two simple moving averages (SMAs) of the midpoints of each bar. The midpoints are calculated by adding the high and low prices of each bar and dividing by two. The AO uses a 34-period SMA and a 5-period SMA and the result is plotted as green or red bars on a separate window below the price chart.
How the Awesome Oscillator works
The AO is an oscillator that fluctuates above and below a zero line, representing the equilibrium between the two SMAs. When the AO is above the zero line, it indicates that the short-term momentum is stronger than the long-term momentum, signaling a bullish trend. Conversely, when the AO is below the zero line, it indicates that the short-term momentum is weaker than the long-term momentum, signaling a bearish trend.
The color of the bars also reflects the momentum of the market. A green bar means that the AO value is higher than the previous bar, indicating an increase in momentum. A red bar means that the AO value is lower than the previous bar, indicating a decrease in momentum. The longer and more consecutive the bars are, the stronger the momentum is.
Using the Awesome Oscillator in trading
The Awesome Oscillator generates various trading signals based on its position and movement relative to the zero line and its own peaks and troughs. Some common signals include:
Zero line crossover
Indicates a change in momentum and trend direction. A bullish crossover occurs when the AO moves from below to above the zero line, signaling a potential buy opportunity. A bearish crossover occurs when the AO moves from above to below the zero line, signaling a potential sell opportunity.
Twin peaks
A bullish twin peak occurs when two troughs develop below the zero line, with the second trough usually having a higher low than the first trough and followed by a green bar. This indicates that the bearish momentum is weakening and a reversal is likely. A bearish twin peak happens when there are two peaks above the zero line, with the second peak usually being lower than the first one and followed by a red bar. This indicates that the bullish momentum is fading and a reversal is possible.
Saucer
A bullish saucer happens when there are three red bars below the zero line, with the second bar being lower than the first and third bars, and the third bar being followed by a green bar. This indicates that the bearish momentum is slowing down and a reversal is imminent. A bearish saucer happens when there are three green bars above the zero line, with the second bar being higher than the first and third bars, and the third bar being followed by a red bar. This indicates that the bullish momentum is losing steam and a reversal is near.
Divergence
Divergence occurs when the price is making higher highs or lower lows, but the AO is not confirming the price action. This indicates that the momentum is weakening and a reversal is likely. Traders can use this signal as a confirmation of a trend reversal and enter a position in the opposite direction.
Bill Williams on the Awesome Oscillator in trading
According to Bill Williams, the Awesome Oscillator can be used in trading to identify trends and potential trading opportunities. He recommended that traders look for two things: a bullish or bearish divergence between the Awesome Oscillator and the price of the asset being traded, which can signal a potential trend reversal, and a change in the color of the histogram bars, from red to green or vice versa, which can indicate a potential change in the trend direction.
Williams stressed the importance of using the Awesome Oscillator in conjunction with other technical and fundamental analysis tools to confirm signals and make informed trading decisions. He suggested using the Alligator indicator, which he also created, in addition to other indicators such as moving averages, trendlines, and support and resistance levels to identify trading opportunities and manage risk. Williams also advised traders to be patient and disciplined and avoid overtrading or taking on excessive risk.
It is important to note that no trading strategy can guarantee success, and traders should always be aware of the risks involved in trading. Traders should carefully consider the advantages and limitations of any strategy before incorporating it into their trading plan and should use the strategy in conjunction with other analysis tools to make informed decisions. Past performance is not necessarily indicative of future results.
Advantages & Limitations of the Awesome Oscillator
The Awesome Oscillator is a popular trading indicator that offers several potential advantages and limitations. Below are some of them:
Advantages
- Trend identification: The Awesome Oscillator can assist traders in identifying trends in the market and possible entry and exit points.
- User-friendly: The oscillator is relatively easy to understand and use, making it accessible to traders of all skill levels.
- Combinable with other indicators: The oscillator can be used with other technical indicators to provide a more comprehensive understanding of market conditions.
- Versatile: The Awesome Oscillator can be applied to various financial instruments and timeframes, making it a flexible tool for traders.
- Momentum shift identification: The oscillator can help traders identify changes in market momentum, which can be helpful in predicting potential trend reversals.
Limitations
- False signals: Like any trading indicator, the Awesome Oscillator can produce false signals that result in potential losses.
- Lagging indicator: As a lagging indicator, the Awesome Oscillator may not always provide real-time information about market conditions.
- Interpretation subjectivity: Interpretation of the oscillator can be subjective, leading to different traders having varying views of the same information.
- Not a standalone tool: The oscillator should not be used as the sole indicator for making trading decisions and should be used with other analytical tools.
- Dependence on historical data: The oscillator relies on past price data, which may not always accurately predict future market movements.
It is important to remember that no trading tool or strategy can guarantee success, and traders should carefully consider the advantages and limitations of any tool before incorporating it into their trading plan.
The Awesome Oscillator is a widely-used trading indicator that can assist traders in identifying trends and possible trading opportunities across various financial instruments and timeframes. This user-friendly tool can be combined with other technical indicators to provide a comprehensive analysis of market conditions.
It’s important to keep in mind that no trading tool or strategy can guarantee profitable trades, and the Awesome Oscillator is no exception. Traders should thoroughly consider the advantages and limitations of the oscillator before implementing it into their trading plan. They should also use it in combination with other technical and fundamental analysis tools to make well-informed trading decisions. In addition, past performance cannot ensure future results, and traders should be prepared for potential losses.
