Simply stated, oscillators represent the differential between two moving averages.
The idea here is to get a more sensitive reading on the market, using moving averages. By monitoring the differential between the 50-day exponential moving average (EXP-MA) and the 200-day EXP-MA, a trader can gauge the strength, or lack thereof, in the short-term move, on a relative basis.
An oscillator also provides a tangible signal that is visible for identifying when the shorter-term moving average crosses over the longer-term moving average. This is reflected by the change in the oscillator from a positive reading to a negative reading or vice versa.
You can define some examples within the precious metals arena noted in Figures 18.1
. In Figure 18.1
, from the end of 2003 through the first quarter of 2004, spot gold is in candlestick form, with my preferred oscillator. This midterm indicator simply measures the 50-day EXP-MA against the 100-day EXP-MA. The divergence is obvious, as the oscillator was into a well-defined downtrend following the first peak set in January 2004 and did not even come close to challenging the highs when gold rallied back above $425 in the spring of 2004.
On the contrary, the oscillator could barely generate a positive reading, with prices at a new high, a technically weak circumstance defined by a lack of near-term momentum. In this case, the oscillator’s bearish divergence turned out to be a valuable sign of internal technical weakness, ...