The Power of Momentum, Divergence & Convergence

Hello Traders!

today’s article will discuss the Awesome Oscillator and how you can use this indicator to your advantage to make more pips!

But before we explain the ins and outs of this indicator, we would like to ask you whether you use a lower case indicator? And if so, which one? Please share with us at the bottom of the article!

Bill William’s Awesome Oscillator

The Bill William’s Awesome Oscillator (AO) is a technical analysis indicator created by Bill M. Williams, a trader and educator who has decades of experience. The indicator is a price based indicator which is shown at the bottom (or above) of the main price chart.

The indicator is designed to show current market momentum and has similarities to another well known momentum indicator, the MACD, The AO is also showed as a histogram and is created using the difference between the 34 period and 5 period simple moving averages of the bar’s midpoints: (High + Low)/2.

As a warning though, a trader should realize that all indicators are lagging. For more information on Forex indicators and tips, click here.

The AO bars, contrary to the typical MACD, have two colors. Green indicates that the current bar is higher than the preceding bar. Red indicates that the current bar is lower than the preceding bar.

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How to use it

The oscillator can be used in these ways:

1)      The change in colors identifies areas and candle sticks when the momentum is losing, maintaining, or regaining its thrust in the current direction.

2)      As with other oscillators, when the histogram bars cross the zero line the momentum of the price action is changing on the time frame of your chart. When crossing from above the zero line to below the zero line, the price action momentum has turned bearish. When crossing from below the zero line to above the zero line, the price action momentum has turned bullish.

3)      The indicator can be used to measure divergence and convergence. When the price reaches an extreme and the AO makes a top or bottom as well, the strength of the move can be compared to the strength of the previous moves.

When the price makes a higher high or lower low, it is useful to check whether the AO histograms are also making a similar higher high and lower low. If yes, the strength and momentum of the move support price action. If not, then it could indicate that the strength and momentum of the move is fading and it could signal a first sign of a potential turn around.

Be careful and only use the AO with other confirmations as the divergence could only cause a small correction, after which price continues with the established trend. In those cases you could see double or triple divergence before a turnaround indeed happens.

If a trader sees divergence, one method is to wait for the color of the histogram bars to change. For example in a bull market wait for the bar color to turn red. In a bear market, wait for the bar color to turn green.

4)      The indicator can be useful as well in counting the Elliot Waves. The histogram measurement at the end of a Wave 1 normally is close to zero line and typically travelled quite a distance to cross it. During the Wave 2 correction the histogram bars usually retrace and re –enter the same zone, but very shallow. Wave 3 sees a very strong momentum pushing the AO to a new extreme far above the Wave 1 top. Wave 4 should see the AO retrace back to the zero line – either remaining in the same zone or slightly crossing. Wave 5 then sees a new burst in the same direction was Wave 3, but the momentum dies out and although price makes a new high or low, the AO peak usually does not.

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Checklist

A useful tool for analyzing the AO could be a check list where one analyzes all 4 points to make a conclusion.

1)      Currency pair

2)      Time frame(s)

3)      Position of the AO – above or below the zero line

4)      The color of the AO histogram

5)      Compare the extremes of price (tops/bottoms) with the extremes of the AO for divergence

6)      Judge whether the AO matches a EW

Of course a currency pair that has green bars above the zero line with no divergence has a strong momentum behind it. Looking for buying opportunities on that chart or on a lower chart makes sense. Looking for shorts would logically not be advisable. Of course always use other methods to establish entries, exits, and take profits. But with keeping an eye on the momentum, a trader will not lose track of the direction.

Multiple time frames

One method that allows for more context is to use multiple time frame analysis. When looking at two, three or four time frames, the trader can judge and analyze the meaning of price and the histogram bar of all time frames relative to each other. This allows a trader to see that a negative AO movement in the lower zone on the 1 hour chart could only signal a retracement of the AO back to the zero line on the 4 hour chart.

For example, a currency that has green bars above the zero line on two time frames most likely signals significant bullishness. A currency that has mixed readings on two time frames could indicate caution.

Retracements

The AO can also be a strong weapon in catching a Fibonacci retracement level. Instead of buying a particular Fib retracement level with a market order at the Fib. A trader could opt for a confirmation of the AO and first await a change of the AO histogram’s color back into the desired direction.

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This is especially useful when a higher time frame is setup for an up move, but is currently making a retracement which is evident by the AO retracing back to the zero line. When the AO approaches the zero line, the trader could monitor a lower timeframe to check for:

a)      Divergence, multiple or even triple divergence

b)      A Fibonacci retracement target or retracement level close by

c)       A change of the histogram color in the direction of the trend on the higher time frame

If you ever wanted to make use of this indicator, please make sure you have done proper testing! See this article about back testing a trading strategy here.
Please let us know if you have any questions regarding this article in the comment box!

Good Trading today, have a great Friday and an awesome weekend!

 

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Chris is the head of the mentoring program and trading room at Winner's Edge Trading. He has a passion for technical analysis and helping Forex traders achieve their goals in trading. Chris has been trading for almost 10 years and is most fond of the Double Trend Trap (as a strategy), moving averages (as an indicator) and Fibonacci (as a tool).

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