Price Oscillator

Advertisement

Introduction

Price oscillator, mathematically, is the difference between two exponential moving averages followed by dividing the larger moving average. Price oscillator is, in most cases, identical to Moving Average Convergence – Divergence [MACD], as the latter one too, uses the difference between moving averages. The main difference is that price oscillator is in percentage terms. That is the reason why it is more accurate and easy to use. Price oscillator, as with many of the other oscillators or indicators, is used to generate signals based on a standard line crossover.

Calculation

Price oscillator is measured in percentage terms. Taking the two Moving averages to be 12 – EMA and 26 – EMA, we calculate the Price oscillator as follows:

  • Step 1: Calculate the difference between 12 EMA and 26 EMA [12 EMA – 26 EMA].
  • Step 2: Now, divide the difference by the longer moving average [26 EMA]. This is the Percentage price oscillator.
  • Step 3: Using the 9 – day exponential moving average as the signal line, we could identify the crossovers.
One more method, is to, divide the MACD by the longer moving average.
  • Note that, the 12 EMA and the 26 EMA are the standard ones used by many traders. You could change those according to your preferences.
Advertisement

Theory

Price oscillators could also be regarded as “MACD’s in percentage terms”. A price oscillator signals a pre-defined move along with the Moving Average convergence – divergence. That means both these indicators identify the upcoming move at similar times. But, why is a price oscillator preferred over MACD? As discussed, it is because of the ease in determining a signal, and its additional features like determination of volatility, etc. A price oscillator works the best, in a trending market. It has the potential to find bullish or bearish signals. But, it is difficult to find its path in a sideways market. Traders will just be hitting their stop losses, if they trade according to these strategies in a choppy market.

It is not necessary that traders should consider the standard Exponential moving averages, 12 EMA and 26 EMA. A price oscillator works by considering any two exponential moving averages [EMA] according to the trader’s preferences.

Interpretation

Based on the signal line crossover [9 day EMA], long or short positions could be initiated. Price oscillator is positive, if the shorter moving average is more in value, than the longer moving average. This indicates a bullish phase. Similarly, if the oscillator is negative, a downtrend is most likely to happen. When the PPO moves in to the positive territory, a buy signal is generated. That is also the point where the 12-day EMA will be moving above the 26-day EMA and hence, a short term up trend is most likely to happen in the coming days.

The range for a MACD is high if the price of the underlying is high. So, it becomes difficult to measure and identify the crossovers, but that’s not the case in price oscillators. No matter how big the share price is, PPO will range between a small and noticeable value. This is one big advantage of a price oscillator over MACD. So, no matter whichever stock or index chosen, a trader will be able to easily identify buy or sell signals.

Price oscillator is also used to measure the volatility in a stock. “The price oscillator’s range for a given stock is higher than the other”, means that the former one is more volatile than the latter one. Traders use this method to identify a high beta stock in a particular sector. So, if a price oscillator for a specific stock is ranging between a higher value than the others in the same sector, then the risks and rewards associated with that specific stock are bigger. If a stock has comparatively bigger difference between the 2 EMAs considered, it implies that the particular stock is volatile and is facing large swings. Mathematically, if the difference between the two considered EMAs, [in this case 12 and 26 EMA] is big, then, it clearly shows that the price oscillator percentage will be a bit on the upside.

Advantages of Price Oscillator

  1. Price oscillator is measured as a percentage. That makes it more simple and convenient to identify crossovers.
  2. It ranges between a small value and that makes it more efficient than MACD.
  3. The uptrends and downtrends in a price oscillator can be used to measure the momentum in the particular stock or an index.
  4. As with many indicators, price oscillator is used to identify a trend before the underlying stock or an index starts behaving.
  5. Despite huge price changes in the corresponding stock or underlying, price oscillator can be used to generate signals.
  6. Price oscillator tends to generate huge returns under trending markets.

Disadvantages of Price Oscillator

  1. Price oscillator always doesn’t identify trends, based on crossovers, as is the case with many indicators.
  2. It cannot be able to show overbought and oversold levels.
  3. A price oscillator doesn’t work under sideways or choppy market.

Conclusion

The main use of a price oscillator is to identify trends before the actual trend starts performing. It is measured on a percentage basis and that is a big advantage compared to MACD. Using price oscillator along with other indicators like RSI, Stochastic oscillator, etc. will make trade more profitable. The main drawback of a price oscillator is its inability to identify overbought and oversold levels. Price oscillators are generally used in trending markets. No matter, how far the stock goes, a price oscillator will be able to depict its movement.