An oscillator is a circuit that generates a repeating waveform, such as a sine wave or square wave. The "Awesome Oscillator" (AO) is a technical indicator developed by trader Bill Williams that is used to measure market momentum.
The AO is based on the difference between the 34-period and 5-period simple moving averages (SMAs) of the bar's midpoint (H+L)/2. The 34-period SMA is subtracted from the 5-period SMA to create the AO. The resulting plot forms a histogram that oscillates above and below the zero line.
Formula
The Awesome Oscillator is calculated using the following formula:
AO = SMA(MEDIAN PRICE, 5)-SMA(MEDIAN PRICE, 34)
Where:
SMA: Simple Moving Average
MEDIAN PRICE = (HIGH + LOW) / 2
5 is the number of bars used to calculate the short-term SMA
34 is the number of bars used to calculate the long-term SMA
When the AO is above zero, it suggests that short-term momentum is stronger than long-term momentum and is generally considered bullish. When the AO is below zero, it suggests that long-term momentum is stronger than short-term momentum and is generally considered bearish.
The AO can be used in several ways to generate trading signals. One of the most common is to look for crossovers of the histogram above or below zero. When the histogram crosses above zero, it generates a bullish signal, and when it crosses below zero, it generates a bearish signal.
The AO can also be used to identify divergences between the histogram and price action. When the histogram is making new highs while price is failing to do so, it can be a bearish divergence and a warning of a potential trend reversal. Similarly, when the histogram is making new lows while price is failing to do so, it can be a bullish divergence and a warning of a potential trend reversal.
The AO can be used in combination with other indicators and analysis techniques to generate more robust trading signals.
It's important to note that The AO is a lagging indicator, it's best to use it in combination with other indicators to confirm signals and get a better understanding of the market conditions.
Best Usage
The Awesome Oscillator is best used in trending markets as it is primarily designed to identify changes in the market momentum. Traders can use it to confirm the strength of an existing trend or identify potential trend reversals. It is not recommended for use in choppy or sideways markets as it can produce false signals.
The Awesome Oscillator can be used in conjunction with other indicators such as moving averages, trend lines, and other momentum indicators to confirm signals and reduce false signals. Traders can also use it alongside oscillators such as the Relative Strength Index (RSI) to confirm momentum and overbought/oversold conditions.