How to Use and Read the Awesome Oscillator
The Awesome Oscillator (AO), a brainchild of Bill Williams, is a crucial tool in technical analysis, giving traders a clear view of market momentum and potential trend shifts. Designed as a histogram oscillating around a zero line, the AO provides nuanced insights into asset momentum. In this article, we explore the intricacies of this indicator, including its calculation, applications, and uses alongside other tools.
What Is the Awesome Oscillator?
The Awesome Oscillator is a momentum-based technical analysis tool designed to evaluate and visualise market dynamics in relation to a specific timeframe. Developed by Bill Williams, a renowned figure in the realm of technical analysis, the Awesome Oscillator quantifies the distinction between a 5-period simple moving average (SMA) and a 34-period SMA. Both these SMAs are calculated using the median points of the price bars (the average of the high and low prices for the period).
The rationale behind the specific Awesome Oscillator settings (5 and 34) is rooted in the natural and ancient mathematics of the Fibonacci sequence. The proximity of these numbers to Fibonacci ratios offers traders a balance between short-term and longer-term price actions, capturing the essence of market momentum.
Presented as a histogram, the AO oscillates around a zero line. Its design aims to pinpoint potential trend changes and confirm the prevailing trend's strength. The AO's simplicity and clear visual representation make it a favoured tool among traders, helping them gauge the momentum of an asset and anticipate potential shifts in market sentiment.
Awesome Oscillator Formula and Calculation
The Awesome Oscillator is constructed based on the difference between two simple moving averages (SMAs) of varying timeframes, focusing on the median price of a security. Here’s a step-by-step breakdown of the formula and how it is calculated:
1. Median Price Calculation:
- For each period, calculate the median price. The median price is determined by taking the average of the high and low prices of that specific period.
Median Price = (High + Low) / 2
2. Compute the 5-Period SMA of Median Price:
- Sum up the median prices for the last 5 periods and divide by 5.
5-Period SMA = Sum of last 5 median prices / 5
3. Compute the 34-Period SMA of Median Price:
- Sum up the median prices for the last 34 periods and divide by 34.
34-Period SMA = Sum of last 34 median prices / 34
4. Determine the Awesome Oscillator Value:
- Subtract the 34-period SMA from the 5-period SMA.
AO = 5-Period SMA − 34-Period SMA
The resulting histogram visually portrays market momentum through its bars. When bars are above the zero line and are green, it underscores a strong bullish momentum. Conversely, red bars above the zero line suggest a diminishing bullish momentum. Below the zero line, green bars hint at a potential bullish turnaround despite the prevailing bearish trend, while red bars emphasise continuing bearish momentum.
How to Use the Awesome Oscillator Indicator
Trading with the Awesome Oscillator can help identify market momentum and potential reversal points. Let’s take a look at how to read the Awesome Oscillator. If you’d like to put these signals into practice, head over to FXOpen’s free TickTrader platform and add the indicator to your chart.
Bullish and Bearish Saucers
Bullish Saucer: This formation occurs when you observe a succession of three columns on the AO histogram above the zero line: a red bar followed by a smaller red bar, culminating in a green bar. This setup indicates a potential bullish turn in the market. Essentially, it suggests that bearish momentum is waning, and a bullish surge might be on the horizon.
Bearish Saucer: The inverse of the bullish saucer, a bearish saucer forms when you see a green bar followed by a smaller green bar, ending with a red bar on the histogram below the zero line. This pattern hints at a possible bearish reversal, suggesting that bullish momentum is slowing down, making way for a potential downward movement.
Zero Line Crossover
Bullish Crossover: When the AO histogram moves from below the zero line to above it, this indicates a bullish crossover. It's a sign that buying pressure is increasing, and the market might be entering an uptrend.
Bearish Crossover: Conversely, when the AO moves from above the zero line to below it, this signifies a bearish crossover. This movement suggests rising selling pressure, potentially signalling the onset of a downtrend.
Twin Peaks
Bullish Twin Peak: This pattern is characterised by two successive lows below the zero line, where the second low is higher than the first. The bullish twin peak is confirmed when the AO histogram crosses above the zero line after forming the second low, signalling a potential upward movement.
Bearish Twin Peak: A bearish twin peak involves two successive highs above the zero line, with the second high being lower than the first. Confirmation of this bearish signal comes when the AO histogram subsequently moves below the zero line, hinting at a possible decline in the market.
Divergence with Price
Bullish Divergence: This occurs when the AO forms a higher low while the price chart plots a lower low. This divergence suggests that despite the declining prices, the underlying momentum might be turning bullish.
Bearish Divergence: If the AO marks a lower high while the price makes a higher high, it indicates a bearish divergence. This pattern hints at potential bearish momentum even if prices seem to be rising.
How to Combine the Awesome Oscillator Indicator with Other Technical Analysis Tools
Integrating other indicators with this tool can be used to create a comprehensive Awesome Oscillator strategy. Here are some ways traders commonly merge AO with other trading tools:
Moving Averages
- Purpose: To validate AO signals and identify potential trend confirmations.
- Method: When both AO and a shorter-term moving average (like the 20-period SMA) show a bullish crossover from their respective baselines, it can solidify a bullish sentiment. Conversely, simultaneous bearish crossovers can strengthen a bearish outlook.
MACD (Moving Average Convergence Divergence)
- Purpose: To recognise momentum shifts and potential trend changes.
- Method: Both AO and MACD assess market momentum. For instance, when both indicators show bullish divergence with the price, it can be a strong signal of a pending upward reversal. If AO shows a bullish crossover and the MACD line is above its signal line, it can further confirm the bullish momentum.
Stochastic Oscillator
- Purpose: To confirm overbought or oversold conditions alongside AO signals.
- Method: If the AO indicates a bullish trend (for example, via a bullish saucer) and the Stochastic Oscillator is below 20 (oversold territory), it might reinforce the bullish signal. Similarly, a bearish signal from AO combined with a Stochastic reading above 80 (overbought) can accentuate the bearish perspective.
The Bottom Line
The Awesome Oscillator, as explained, provides traders with an intuitive representation of market momentum. Understanding and applying the Awesome Oscillator in forex and other markets can offer valuable insights. For those interested in harnessing the full potential of the AO forex indicator, pairing it with other technical tools can elevate its efficacy as it may provide incorrect signals.
If you’re looking to put your AO indicator strategy to the test, consider opening an FXOpen account. When you do, you’ll gain access to advanced tools, a wide range of markets, and ideal trading conditions. Good luck!