Rainbow Oscillator

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Introduction

Ever since the people concluded that stock market price movements are not random or chaotic, but follow specific trends that can be forecasted, they tried to develop different tools or procedures that could help them identify those trends. And one of those financial indicators is the Rainbow Oscillator Indicator. The Rainbow Oscillator Indicator is relatively new, originally introduced in 1997, and it is used to forecast the changes of trend direction.

Essential Assumptions

In 1997, to better determine stock market trends, Mel Widner, Ph.D. created the Rainbow Charts and Rainbow Oscillator and published them in Stocks and Commodities magazine. The Rainbow Charts indicator is a trend-following indicator. It is based on a two-period simple moving average. Over that, recursive smoothing is applied to the original MA (moving average) to create nine additional moving averages, each being based on the previous MA. Through a process of repetitive smoothing, the result obtained is a full spectrum of trends, which plotted on a chart with continuous colors, have the appearance of a rainbow. The Rainbow Oscillator Indicator is, like the Rainbow Charts, an indicator used to follow trends and its graph is plotted based on the same calculations made to find the Rainbow Charts. The oscillator is a derivative from a consensus of the Rainbow Charts trends, defining the highest high value and lowest low value among those moving averages, and creates an oscillator and bandwidth lines according to those calculations.

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Calculations

The calculation and chart designing method of the Rainbow Oscillator Indicator is a two period simple moving average. Afterwards, nine extra moving averages are designed, with each new moving average based on the previous moving average. Thus, a total of ten moving averages are created and in a chart, the plot appears like a rainbow.

r1:= Mov (C,2,S);
r2:= Mov (r1,2,S);
r3:= Mov (r2,2,S);
r4:= Mov (r3,2,S);
r5:= Mov (r4,2,S);
r6:= Mov (r5,2,S);
r7:= Mov (r6,2,S);
r8:= Mov (r7,2,S);
r9:= Mov (r8,2,S);
r10:= Mov (r9,2,S);

The Rainbow Oscillator indicator is based on the above calculations and it defines the highest high and the lowest low of the moving averages. Ergo, an oscillator and bandwidth lines are created based on those calculations.

Interpretation

The Rainbow Oscillator indicator is used, as most of the financial indicators, to predict with a certain rate of accuracy the trends of the market. When a market is rising and the trend is to go up, the most abrupt line is as the top of the Rainbow and the smoothed line is at the bottom of the Rainbow. Contrarily, when the market is declining and the trend is to go down, the Rainbow is reversed: the least smoothed line is as the bottom and the smoothest line as at the top of the Rainbow.

As market prices go up and down, the oscillator appears as a direction of the trend, but also as the safety of the market and the depth of that trend. As the rainbow grows in width, the current trend gives signs of continuity, and if the value of the oscillator goes beyond 80, the market becomes more and more unstable, being prone to a sudden reversal. When prices move towards the rainbow and the oscillator becomes more and more flat, the market tends to remain more stable and the bandwidth decreases. Still, if the oscillator value goes below 20, the market is again, prone to sudden reversals. The safest bandwidth value where the market is stable is between 20 and 80, in the Rainbow Oscillator indicator value. The depth a certain price has on a chart and into the rainbow can be used to judge the strength of the move.

The Rainbow Charts indicator and the Rainbow Oscillator indicator are basically the same indicator, with the only difference being in the graphs they plot. They both show the same market orientation to trends, but the Rainbow Oscillator is easier to read, given its bandwidth on the chart.

Conclusion

Since people have arrived to the conclusion that markets are not random, they have continuously tried to determine a specific and secure way to predict the movements the markets are the most predisposed to make. Therefore, traders have developed financial indicators to help them forecast the market trends in logical and exact ways. Mathematics has always helped in the definition of said indicators, and market investing has proved itself to be a science that day by day becomes more exact. Mel Widner introduced a colorful technique for plotting an indicator to signal trend changes. The indicator is derived from a consensus of trends that has the appearance if a rainbow, when is plotted in color. The Rainbow Charts indicator is used, together with the Rainbow Oscillator, for buying and selling signals, as well as determining overbought and oversold positions.In conclusion, everyone can invest successfully in the market as long as they have the little programs that help create the easy –to-read and self sufficient financial indicator charts.