Price is the primary focus of my stock trading system because it’s the purist representation of supply and demand. It’s handy to compare where price has been in relation to where it currently resides. That’s basically what an oscillator does.
An oscillator moves in waves. Many traders watch an oscillator at pre-defined levels calling those readings either overbought or oversold.
Price Rate Of Change (ROC) is a technical indicator that measures the amount that price has changed over a fixed period of time. For a customized and effective oscillator try this: combine three different rate of change readings into one indicator. For example, my oscillator will be a combination of three ROC lengths. K = ROC ( Close, 5) + ROC (Close, 13) + ROC (Close, 21).
The combo ROC from above is very erratic when plotted on a chart. It’s the blue line in the lower pane. There is also a zero line plotted for a reference point.
The customized ROC catches many of the peaks and valleys on this price chart of Arch Coal. My preference is to plot an exponential moving average of the customized ROC. That smooths the indicator without losing its effectiveness.
Here’s the same chart, but with only the exponential moving average of the ROC — EMA(K, 5). That formula will plot a 5 period exponential moving average of K (K was my customized ROC indicator).
If you like to build indicators, try this one. It does a pretty good jobs of catching tops and bottoms on a herky jerky stock like ACI.
Oscillators don’t work well with trending stocks or in trending markets. Notice how the trend from March 2009 until April 2010 has moved smoothly upward on this chart of AAPL. But look at our indicator during the same time period — all over the chart, both up and down.
It’s possible to still use an oscillator in a trending market, but it should be paired with a trend following indicator like a moving average. The yellow line on price is a 50 period exponential moving average. During an up trend, it supports price as it moves upward.
A trading system for this indicator may be that long trades will begin when price moves above the 50 EMA and the MAROC is greater than zero. A simple sell signal could be when price closes below the 50 EMA and the MAROC is less than zero and declining.
I’m sure you can think of many more ways to use a composite oscillator like the MAROC. If you like to tinker with indicators I hope you’ve acquired a few ideas for your stock trading system.
