No exploration of technical indicators would be complete without investigating the world of momentum indicators.
There are numerous to choose from including the popular RSI and Stochastic indicators, however, in this article we are going to look at a momentum indicator from a range of trading indicators developed by the legendary Bill Williams – The Awesome Oscillator (AO).
We will look at:
what the Awesome Oscillator is, briefly how it works, how to install it on your charts and then we will look at a few ways in which you can use the Awesome Oscillator when trading.
Let's begin...
Momentum indicators graphically demonstrate how rapidly the price of a given instrument is moving in a particular direction.
They can also indicate whether the price movement is likely to continue on in its current direction. The idea behind the momentum indicator is that as an instrument is traded, the momentum of price reaches a maximum when money invested into a particular trade is at its peak.
After peak momentum/investment, when there is less new money available, the tendency is for the price trend to flatten or reverse direction. Hence the feeling of riding a wave when you catch momentum early in a trend and watch price rapidly go in your favour, before the energy of the wave peaks and subsides.
Momentum indicators graphically demonstrate how rapidly the price of a given instrument is moving in a particular direction. They can also indicate whether the price movement is likely to continue on in its current direction.
The idea behind the momentum indicator is that as an instrument is traded, the momentum of price reaches a maximum when money invested into a particular trade is at its peak.
After peak momentum/investment, when there is less new money available, the tendency is for the price trend to flatten or reverse direction. Hence the feeling of riding a wave when you catch momentum early in a trend and watch price rapidly go in your favour, before the energy of the wave peaks and subsides.
Bill Williams is an American trader and author of books on trading psychology, technical analysis and chaos theory in trading the stock, commodity, and foreign exchange markets.
Bill Williams believed that the markets were random in nature and that they were best exploited through trading psychology and understanding the nature of chaos.
He believed that trading technical indicators or fundamental analysis alone, lead to only average results, whereas approaching the markets from more of a random or ‘chaos’ standpoint, a trader could implement trading psychology to greater financial success.
His unique theory combined trading psychology and chaos theory and led him to develop a range of technical indicators, which are available in most trading packages in all markets.
The Awesome Oscillator (AO) is a ‘centred’ or ‘no limit’ oscillator which means that it moves up and down freely around a center zero line.
The AO determines market momentum at any point in time by comparing the momentum of the last 5 bars to the momentum of the last 34 bars, displaying the result as a histogram (bar chart)
The AO is simply calculated as the difference between the 34-period and 5-period simple moving averages applied to the bar's midpoints i.e.
The median, (H+L)/2.
Figure 1 below, demonstrates the calculation and presentation of the histogram.
So, if you plot the 5 and 34 simple moving averages applied to the Median Price (H+L)/2 and drop vertical lines where they cross over on the chart, you will find the zero cross points of the AO histogram.
The profile of the histogram is then the difference between the two moving averages but graphically displayed on a linear chart.
You can see that sharp price moves are represented by equally sharp and elongated rises and falls in the histogram, since the 5MA reacts far quicker to momentum changes than the 34MA and therefore the differences at these periods of rapid change are also clear to see.
The colour changes of the histogram, from green to red and vice versa, represent the slope of the histogram, which effectively corresponds to the slope and direction of the 5 period moving average.
Next, we’ll talk through applying the indicator to your charts (on MT4), before looking at how to read the AO, what the various signals mean and understanding how we could use the AO to our advantage when trading.
Attaching the AO to your charts is easy.
There is no configuration to be done and it is attached in the same way as any other indicator. It’s easy to find, since in MT4 there is a Bill Williams indicator folder full of the Bill Williams indicators, ready for you to use.
Step 1. Open MT4 on a chart you want to attach the Awesome Oscillator indicator to
Step 2. Open the ‘Navigator’ panel, either from the tab ‘View’, ‘Navigator’ or click the icon on the top panel which has a yellow folder with a gold star on it.
Step 3. Expand the ‘Bill Williams’ folder and locate the Awesome Oscillator file
Step 4. Either double click on the Awesome Oscillator file or drag and drop the file onto your chart
Step 5) Change the colours or the thicknesses of the histogram lines and then click ‘OK’. And there you have it.
The Awesome Oscillator will now be at the bottom of your chart.
How to read the Awesome Oscillator (AO)
There are several ways to read the Awesome Oscillator and to use the information it provides to make stand-alone buy/sell trading decisions. The first way, and perhaps the most straight forward to understand, is the Zero Line Cross.
As a momentum indicator, the AO gives us several bits of useful information….The speed at which momentum is picking up (how steep the angle of change), a visual quantitative indication (the size of the humps) and when buying/selling pressure starts to die off (the humps get lower and/or they change direction).
When selling momentum dies off and buying momentum picks up speed, the histogram colour changes from red to green and goes from negative to positive, crossing the zero line in a sea of green bars.
Once price is above the zero line, you are looking to place buy trades only.
Conversely, when selling momentum takes the reigns, the histogram colour changes from green to red and crosses the zero line from positive to negative in a sea of red bars. Once the histogram is below zero, you are only looking to place sell trades.
Let’s have a look at this concept in action.
In Figure 3 above, you can see the zero crosses highlighted by orange vertical lines.
When buying momentum is predominant and the histogram goes positive, we get the positive zero line cross.
The opposite happens when selling momentum takes over.
The classic long or buy entry signal is produced by the first green positive bar that prints on the histogram, after the zero line cross to the upside. The classic short or sell entry signal is produced by the first red negative bar that prints on the histogram, after the zero line cross to the downside.
Potential zero line cross entries have been highlighted in figure 3.
The green and red arrows indicate zero line cross buy/sell signals, the horizontal red lines represent the high/low of the signal bars and the blue arrows indicate potential profit from taking such trades.
In fact, out of six potential trades in this example, potentially five of them could have yielded profit, with the one highlighted by the blue circle being the one loser, depending on your risk management and the rules of your trade strategy.
Ok, so this time we are looking for saucers!
The ‘saucers’ we are looking for are ringed in blue in the above figure 4.
They are not ‘saucers’ as such but they are an arrangement of 3 bars which give the impression of a rounded valley. The vertical orange lines highlight the signal bars (histogram and candles) and the red horizontal lines indicate earliest possible entry based on the signal candle close (high/low).
The idea is as follows:
An Awesome Oscillator Saucer buy signal is generated when the histogram (above zero) changes its direction from falling to rising i.e. when the histogram falls due to a lack of, or weakened buying momentum (creating a pull back or retracement of some kind) and then begins rising again, printing a higher green bar
The signal bar (highlighted by a short vertical blue arrow in figure 4) is green and is higher than bar 2 which must be red. Bar 1 must be higher than bar 2, but can actually be any colour (shown in red in figure 4 above)
An Awesome Oscillator Saucer sell signal is generated when the histogram (below zero) changes its direction from rising to falling i.e. when the histogram rises due to a lack of, or weakened selling momentum (creating a pull back or rally of some kind) and then begins falling again, printing a lower red bar
The signal bar (highlighted by a short blue vertical arrow in figure 4) is red and is lower than bar 2 which must be green. Bar 1 must be lower than bar 2, but can actually be any colour (shown in red in figure 4 above)
Only buy if the current histogram bar is green and only sell if the current histogram bar is red.
This is just an outline of the Bill Williams rules, but how the signals are incorporated into a trade strategy is up to the individual. In essence, the signals are representing a continuation trade, appearing after a pullback in a trend and after price has reversed and trend momentum has resumed.
3. The ‘Twin Peaks’ signal
To understand the Twin Peaks signals, we need to be able to read divergence.
Divergence is a phenomenon that many oscillator indicators exhibit.
In it’s simplest form, divergence occurs when price continues to make new highs in an uptrend when the oscillator or momentum indicator is making corresponding lower highs, or conversely when price continues to make lower lows in a downtrend but the oscillator or momentum indicator makes corresponding higher lows.
This behaviour is called divergence and can be an indicator of slowing momentum in a trend and/or an indication of a potential or imminent reversal.
Divergence signals when corroborated by certain price behaviours, can give leading indication of reversals which can then be potentially very powerful signals.
However, only a few signals end up in significant reversals, instead indicating that a retracement or pullback is due within the current trend. Nonetheless, divergence is a powerful behaviour to be aware of and important in identifying Twin Peaks signals with the Awesome Oscillator.
Ok, back to Twin Peaks.
Have a look over figure 5 below and try to absorb some of the information shown.
The Twin Peaks buy signal is the only buy signal that is created from below the zero line of the histogram.
If you look at the histogram in figure 5 on the very left, you will see a set of progressively higher lows. If you look at price above, you will notice that for each of the higher lows of the histogram, there is an equivalent lower low in price. This is divergence in action!
The first buy signal is created by the second histogram higher low from the left.
The blue lines are just highlighting the divergence between the histogram and price.
The twin Peaks buy signal is created by the first green bar printed after peak-to-peak divergence has been identified. It is the first green bar which would indicate momentum in the direction of the histogram…i.e. upwards.
The red horizontal lines represent earliest possible trade entries, as used before for the other signal types.
The first trade wouldn’t have got far as price is in a sharp downtrend and although divergence was present, the trade fails soon after opening.
The Awesome Oscillator demonstrates divergence again after the next price leg down and this time we have a better trade opportunity, depending on your risk management and trade plan.
The next opportunity is a sell trade opportunity which comes at the end of the retracement created at the previous buy trade opportunity.
We see the classic Twin Peaks, showing strong divergence between both price and Awesome Oscillator, with clear differences in peak heights. A good trade opportunity presents itself, in the direction of the momentum of the prevailing trend, which is always the preferred way to trade these signals.
We then see a succession of another three trade opportunities, each to varying degrees of success, but all potentially profitable.
In this article we have explored the concept and uses of the Awesome Oscillator.
We have learnt a bit about it’s creator, Bill Williams, have learnt what the Awesome Oscillator is, how it works and how it can be used to generate potential trade signals. We have also briefly made sure you can attach it to your charts, being freely available with all major trading packages.
For such a relatively simple concept, the Awesome Oscillator generates a number of different, frequent and sometimes very profitable trading signals.
However, no indicator is perfect and no indicator generates perfect signals.
Like many other indicators of it’s variety, the Awesome Oscillator should never be used in isolation. Other analytical techniques and/or other indicators could be used in conjunction with the AO to filter potential trade signals to increase it’s potential profitability as a trade signal generator.
Although the AO does a pretty good job at highlighting momentum strength and speed, one of it’s major drawbacks is in it’s inherent lagging nature, as with all price derived indicators. A lot of the signals come ‘late’, arriving after momentum has already pushed price past some of the best and early entry levels.
Having said that, get in on the right trends and not only are you at a safer place to enter, but there is a good chance that it gets you in on reversals with good opportunities to profit and with very little to think about.
As a re-cap of the trade signals, The Zero Line Cross represents a straight forward momentum buy/sell trade signal, the Saucer signal represents a trade continuation signal and the Twin Peaks signals are actually a divergence / potential counter trend trade signal and as such should be appropriately managed.
Since all instruments have their own personalities, as described by their price behaviours, most indicators react differently to each of them.
The best thing to do with all indicators that you have an interest in familiarizing yourself with further, is to just play with them on your charts and on different time frames, and see what makes sense and/or works for you.
There is no substitute for getting to know an indicator in detail and hopefully this article will have given you a good start in the right direction if you consider looking at the Awesome Oscillator further.
As always, ensure you have a detailed trade and risk management plan in place before trading any new indicators, strategies or instruments and make sure you have back and forward tested your ideas thoroughly before risking real money.