Oscillators such as Stochastics,RSI,ROC are important tools in the hands of a trader trading on technical analysis.

But
oscillators are generally used in a wrong way and the common reaction of traders is to sell if the oscillator goes into
overbought zone and buy once it moves in oversold zone.
The above is too simplistic way of trading with an oscillator....here we will discuss some nonconventional ways.....
Best wishes for the " Oscillating Roller Coaster Journey"
I would like to share an important phenomenon regarding oscillator overbought/oversold conditions. Whenever an oscillator
like Stochastics,( or even RSI,ROC etc ) stays above the overbought limit for more than 5 bars without taking a dip from
overbought to neutral zone....the market has a lot of steam left further to go up, market then continues upward journey,then
comes down,then goes into overbought zone again but shows negative divergence and then only it comes down...till then it
keeps making higher tops. This is a very strong bullish signal to trade.....
Mirror image for oscillator staying in oversold region for more than 5 bars...
The above phenomenon was what was happening towards the later part of the session yesterday (26-06-09).... I traded this
observation yesterday and thought I will share with all....
I am posting Bank nifty fut 5 min chart of 26-06-09 which is used for day trading.....the top panel is a stochastic oscillator....I
have marked 80 and above as overbought zone
The market goes from overbought to oversold and so on so forth in a trading or sideways market environment...so selling in
overbought and buying in oversold zone is a good strategy....but somewhere markets start trending and that is where the
trouble starts for our oscillator trader.
Observe in the chart that when market stays in overbought region for more than 5 bars ...it is extremely overbought and
selling it is incorrect....market needs to dissipate this overbought reading and till then it will blast off on the upside and our
oscillator trader will keep on selling in a market which is blasting off ....The correct action here is BUY....not sell...
I have a question here. Oscillators like Stoch has 2 lines. One fast moving K and another slow moving D.Usually it will happen
that the fast line will cross into overbot zone before the slow one does. Usually, a lag of 2-3 candles will take place.
So, for counting 5 bars, what should we consider? When should our counting begin? When both the slow and fast have crossed
over into overbot/obversold zone or when the fast moving indicator crosses?
Slow line is basically the moving average of the fast line...done for smoothing...so if you are a very aggressive trader...start
counting from fast line...if you are a bit relaxed type...start counting from slow line...the aggressive trader counting on fast line
will have more trades,early entries but also more whipsaws.....part of the game we are in....

To understand the correct way of trading on oscillators let us study the Nifty futures 60 min chart. The stochastic oscillator
is doing a great job till May 09end...calling each top and bottoms and our oscillator trader is on a high and feels that he has
figured out everything in the markets and he is on his way to top the next batch of Market Wizards......But market has its own
ways...we all know that....

All of us have been there....

The problem areas for the oscillator trader are as under :

1) Up trending market from 27-5-09 ,1:00 bar to 2-6-09 ,11:00 bar
2) Up trending market from 9-6-09 ,3:00 bar to 12-6-09 ,12:00 bar
3) Down trending market from 12-6-09 ,3:30 bar to 16-06-09,12:00 bar
4) Down trending market from 17-06-09 ,3;00 bar to 18-06-09 ,3:30 bar
If he can handle the above 4 markets successfully,our oscillator trader is the king....
Let us see how he can handle these periods...I will explain first two cases,rest 2 are mirror images...
1) 27-05-09 ,1:00 bar onwards.....
On 27-5-09 at 1:00 bar the stochastic oscillator goes into overbought zone and that is a mouth watering trade for our trader
friend to go short ( most will trade like this and repent later ). He goes short and gets killed in the subsequent market acyion.
The Oscillator Entry Qualifiers For Short Tradeare as under :
1) The oscillator should have gone to overbought zone.
2) Wait for a bar where the oscillator flips...ie comes out of overbought zone and comes in neutral zone....
3) In doing step No 2 the oscillator should not have stayed in overbought zone for 5 bars and more

4) Wait for a downclose ( meaning close less than earlier day's close)
5) Ensure that by that time oscillator does not go very near oversold region
6) Sell when the low of the downclose bar is broken on downside.....
If you observe all 6 qualifiers you will see that there was no shorselling opportunity in this uptrend.....our trader friend is home
safely....and made money in longs....
2) 9-6-09 ,3:00 Bar onwards
Oscillator went into overbought territory and stayed there for 9 bars.....so no shortselling ideas to be entertained....
Here the market will move to neutral zone,dissipate the extra bullish pressure ,then go to overbought region,fulfill all 6
qualifiers,give negative divergence and then change its direction to down...let us see what it did...
Come to 12-06-09 ,12:00 bar...after dipping into neutral territory the oscillator has gone to overbought zone again....it stayed
there only for 1 bar.....next bar 1:00 it dips again into neutral zone,gives a downclose...Now all qualifiers satisfied...the low of
the 1:00 bar cracked in 12-6-09 , 3:00 bar and that is an ideal sell entry....mkt never looked up after thatAlso note the
classic negative divergence here,the mkt making new higher top oscillator making lower top....all perfect...
The other two are mirror images in downtrend.Our friends can easily figure them out well .....
The Oscillator Entry Qualifiers for a Long Trade are as under :

1. The oscillator should have gone to oversold zone.

2. Wait for a bar where the oscillator flips...ie comes out of oversold zone and comes
in neutral zone....
3. In doing step No 2 the oscillator should not have stayed in oversold zone for 5
bars and more
4. Wait for an upclose ( meaning close more than earlier bar's close)
5. Ensure that by that time oscillator does not go very near overbought region
6. Buy when the high of the upclose bar is broken on upside.....
The oscillator trade entry qualifiers can be used to perfect the trade entry on any timeframe...we have seen 5 min and 60 min
TF examples...now let us see daily TF example...
The chart posted is a Bank Nifty chart for Dec 07-March 08 period...
The stochastic oscillator went into overbought region in a strong bull market on Dec 04,2007 and if we apply the entry
qualifiers.we are saved from a premature short trade and susequent stoploss....The oscillator stayed in OB region for 8 days
indicating market very strong...the bull pressure needs to dissipate.......
The stochastic again went to OB zone on 31-12-07 but again qualifiers saved us....the indicator stayed in the OB region for 7
bars....hmmm not yet good time to sell....bull pressure needs further dissipation.....
Finally the indicator goes in OB region again on 15-1-08 stays there only for a day ,next day gives a downclose and flips to the
neutral zone....ah....now we look for a sell opportunity......The low of the downclose bar was cracked on 18-1-08 and that gave
us a great sell and the market never looked back and crashed by more than 3000 points and the rest is history....
Is this qualifier never fail...holy grail ? Nothing in trading is failproof...but this qualifier will save you from 80 % of oscillator
whipsaws....is n't that a great news ?
I am glad that you liked the oscillator example in my post....thanks...
for day trading you have to go for 5 min or 10 min timeframe and use 8,3,4 stochastic settings....it will identify buy and sell
zones pretty well....you have to see stochastic chart for the underlying ie nifty and if nifty is taking off from oversold region
buy calls/sell puts.....and if nifty is coming down from overbought area,buy puts/sell ATM calls....
Options work great intraday.....I trade them too intraday....
Pivot based trading methods are great ...they are trend following methods and work very well in trending markets...where as
oscillators are trading or sideways market indicators....they work well in sideways market...we have both types of markets...so

different tools for different jobs...

We must have as many indicators pointing toward a particular direction as possible even if we are trading pivot based methods
to stack the odds in our favour....a PL break and oscillator giving a valid sell from overbought zone is a very potent sell signal...
I use oscillators as confirming indicators....not as trading systems...but I have traded quite successfully on oscillators alone and
I know that if handled well they give you great edge in trading.
We are friendly with pivots,flow,oscillators....no quarrel with any method....
method....

.Anything that gives us an edge is our

Smart Trade Sir,

It is sad to see that u not mentioning the name Thomas DeMark, while everything
discussed here is the research result by him.
It reminds me what he says in one of his books, on why he decided to write the book.
pls take in the right spirit.
Hello Joy,
I never claimed that it is my own original research....these applications are based on original research done by Thomas
DeMark....and I have no issues acknowledging the same.
Thomas DeMark wrote the book because his methods were wrongly being presented to the public ...do you find anything wrong
in the methods presented ? If so let me know...I would correct myself....
Did not mention Thomas DeMark name as his langauge is difficult to understand so presented the qualifiers in my own
language for people to understand..... The purpose is that people should understand the technique correctly and not claim that
I did this research and found out these methods... understanding how to use an indicator is more important than who invented
that indicator...
But I am glad that you brought this up....that gave me an opportunity to mention DeMark and hope that you being a DeMark
follower ( we had interacted a lot in Sequential thread ) will contribute something more than who invented these techniques....
For those who are interested in learning more about oscillators,their construction,use etc...can go through " New Market
Timing Techniques" by Thomas DeMark.It is a Wiley publication and one of the best books on Technical
Analysis....
He has developed many unconventional oscillators and my favourite is TD REI...DeMark's language is very difficult to
understand and that is why I chose to work with stochastics and did not introduce REI in this thread....I remember that I used
to break long sentenses of DeMark into 3-4 small sentenses when I was studying DeMark techniques. But a serious trader who
wants to work on trading ideas will find many in DeMark's books ( 3 books in all)