The complete guide to awesome oscillator: calculation formula, how to interpret it and use in your trading strategies

One of great complimentary trading tools, Awesome oscillator is commonly used for day trading and mid-term strategies. In this article, you will find out how to calculate the oscillator, ways to interpret its signals and to use it in your trading strategies.

What is the Awesome Oscillator Indicator?

The Awesome Oscillator, along with the Alligator indicator, is another brainchild of the famous trader Bill Williams. Williams first introduced it in his book “New Trading Dimensions: How to Profit from Chaos in Stocks, Bonds, and Commodities”.

This is a trading tool used for analyzing price trends and upcoming changes in the market sentiment regardless of movements - upward or downward. The Awesome Oscillator shows the strength of the trend over a short period relative to the strength of the trend over a long period.

In the trading terminal, it looks like a histogram under the price chart. Its values change relative to the zero line, the color of its columns also changes depending on the price dynamics (usually green and red). It helps the trader make the right decisions when assessing the market.

The name “awesome” probably appeared because the author himself was very proud of his indicator and considered it “the best momentum indicator available in the stock and commodity markets.” However, in reality, many traders prefer to use the classic moving average convergence/divergence or MACD indicator instead.

Anyway, Awesome indicator proved its efficiency for predicting upcoming trend changes even on short time frames and can be successfully combined with other trading tools and indicators.

Accelerator oscillator vs awesome oscillator

Aside from the above mentioned technical indicators, Bill Williams also developed the Accelerator indicator. It is based on the difference between the awesome oscillator and a 5-period simple moving average. This instrument serves to define early changes in momentum. Besides, it helps traders to predict price changes by evaluating acceleration or deceleration of market momentum.

From the visual standpoint, the accelerator indicator is similar to its ‘awesome’ counterpart: green lines represent upward movements, and red - downward movements. But there are a few differences, though.

When the (Awesome Oscillator) AO crosses the zero line from above or below (does not matter), this is not a trading signal - we just see the signs of possible bearish or bullish periods. The accelerator oscillator allows users to define positive or negative moments to avoid deals that may turn out to be risky. For example, experienced traders don’t recommend buying assets if the last bar on the current chart is red, or selling assets when the last bar is green. This approach helps them make more efficient decisions when entering or exiting volatile markets.

How Awesome Oscillator works

This oscillator was created to evaluate market momentum and define potential trend reversals by comparing a 34-period simple MA to a 5-period simple MA. The simple moving average is calculated by adding the average price of each day and dividing the sum by the number of days from the chosen period.

Consequently, these price movements are displayed on the histogram with two simple moving averages presented and compared. When the 5-period SMA is greater than the 34-period SMA, the histogram gets above zero, which is considered a bullish signal. In the opposite case, when the histogram dives below zero, and the short-term average is less than the long-term average, we see a bearish market coming.

Hence, the awesome oscillator displayed the market momentum by means of the histogram bars moving relative to the zero line. Each bar stands for a single period and will be green when the day’s average is higher than on the previous day (and vice versa for the red color).

How to Calculate Awesome Oscillator

Awesome oscillator is similar to the popular MACD indicator, but for AO, calculations are made not by closing prices, but by median prices. To get AO, the difference between the 5-period moving average 5 and 34-period moving average is calculated. Thus, awesome oscillator is calculated by the formula:

AO = MA (median price, 34) - MA (median price, 5)

MA stands for simple moving average (SMA), and the Median Price is calculated as MP = (High + Low)/2, where:

High - the maximum price of the bar,

Low - its minimum price.

How to read the awesome oscillator

Let’s observe a few use cases - signals generated by the awesome oscillator and how to interpret them:

• One of the standard AO signals is the slope of the bars with their color changing. As a rule, the parameters of two or three successive columns are evaluated. A signal to long position can be a change in slope from downward to upward, when a green column appears after two red bars. The bars must be above the zero line. The signal to sell will be the pullback situation - the bars are below the zero line, two of them are red, the third is green.
• Crossing zero level is also a signal. For example, a buy signal would be two green bars, one of which is below the zero line, and the other is above it. The signal to sell will be two red columns, one above the zero line and the other below it.
• Trend reversal signals can be two columns of the same color if they are located on the same side of the zero level. An uptrend is indicated by a higher high of the second column, a downtrend is indicated by a lower low of the second column.

The Awesome Oscillator also allows you to spot divergences. If, for example, the price makes new highs, and the AO does not show new highs, this is a bearish divergence, the price may go down. Accordingly, a bullish divergence occurs when the price keeps falling, and the oscillator shows an increase, in which case a trend change to an uptrend is expected.

Awesome Oscillator Trading Strategies

The most efficient way to use Awesome oscillator is to look for certain patterns or formations on a trading chart. Here are a few commonly used strategies that can be practiced even by beginners. Please, note that when you see a signal with such patterns, it’s recommended to use other trading tools to confirm your assumptions.

Saucer strategy

“Saucer” is a corrective strategy. A buy order is placed when the histogram bars show a downtrend, reach the zero level but cannot overcome it - growth begins. To implement the strategy, you need to have at least two green columns showing a transition to an uptrend.

A signal to buy during the saucer formation appears when:

1. The histogram is above the zero level.
2. The histogram changes direction from downward to upward. The second column is below the first (colored in red), and the third is a signal column, above the second (green).
3. It is recommended to place a pending buy stop order above the high of the candle that corresponds to the signal column in the histogram.
4. Stop loss can be placed at the low of the signal column price.

A signal to sell during the saucer formation appears when:

1. The histogram is below the zero level
2. The histogram changes direction from ascending to descending. The second column is above the first and is colored green, and the third below the second (red).
3. It is recommended to place a pending order to sell stop below the low of the candle, where the signal column appeared.
4. Stop loss can be placed at the high of the signal column price.

In both cases, at least three columns of the histogram are needed to form the Saucer.

Twin peaks strategy

The Twin Peaks formation shows an uptrend when a double low appears below the zero level. But the order is placed after the formation of at least two columns of the same color, showing a reversal to an uptrend. There are a few rules to mind:

1. If the histogram crosses the zero level in the interval, the “Two Peaks” buy signal is not valid. A buy order should be placed when the histogram keeps below zero at both intervals.
2. The signal bar must be green.

A sell order is placed after the formation of two peak highs above the zero level after two columns of the same color are formed, indicating a trend reversal to the downside. The Twin Peaks shown by the Awesome Oscillator in this case is an analogue of the classic “double top” and “double bottom” chart patterns.

To exercise this strategy, mind that:

1. Being above zero, the oscillator makes two tops, with the second top lower than the first, that is, it is closer to the zero line.
2. The histogram between the formed peaks must be completely above zero. If the histogram crosses the zero level in the interval, the “Two Peaks” sell signal becomes invalid. But the sale comes into force at the “Zero Crossing”.
3. The signal bar must be red.

Bullish or bearish zero-line crossover

This is a simple strategy: when you see the histogram crossing the zero line, it is a signal of trend change.

For example, a buy signal happens when the histogram goes from the area of negative values to the positive area (crosses the zero level from the bottom up). In this case, a stop-loss should be placed above the high of the price, which corresponds to the first column in the positive zone. On the other hand, when the awesome oscillator goes from the positive zone to the negative zone, you should consider opening a short position.

Note that using this strategy alone should be avoided as the indicator crossing the zero line may give you false signals. So trusting it blindly is a surefire way to lose your capital.

Awesome oscillator divergence

Another way to use Awesome Oscillator in your trading strategy is to spot divergences. When the price draws a new extreme, and the Oscillator shows the opposite dynamics, this indicates a fading trend and a high probability of movement in the opposite direction. You can implement the strategy using only one Awesome Oscillator, but it won’t be enough to confirm your predictions.

What Are The Advantages of Using The Awesome Oscillator?

There are several reasons to use Awesome Oscillator in your trading strategy:

1. This is an efficient tool during a trending market.
2. It allows you to measure market momentum based on buying or selling power.
3. It’s a versatile tool that can be used for different types of assets.
4. You can apply it in different strategies to receive trading signals.

What Are The Limitations of Using The Awesome Oscillator?

As we have already mentioned, using the Awesome Oscillator alone can be a misleading strategy because it may generate false signals. Hence, it’s important to find blind spots in setups and discover ways to reduce risks. There are two typical situations when the Awesome Oscillator may lead you to mistakes:

1. If you are a contrarian trader, you may be tempted to open a trade in the opposite direction from the major market trend. You may assume that the asset will not move further than the current extreme (high or low). This is where you risk making a serious mistake. How to avoid it? Look at the histogram: expansion of the oscillator in one direction signals a strong trend.
2. Secondly, reading on slow-moving stocks can be misleading, especially in short timeframes. You may see the histogram going firmly in a certain direction, but then the price shows divergence. That’s why you should consider using additional trading tools to assess the market situation.

Conclusion

Awesome oscillator is a convenient tool for defining market trends - it can be used by both beginners and seasoned traders. Thanks to its comprehensive visuals and customization, AO can be applied to any timeframe, but proves to be particularly useful for short- and mid-term trading.

However, this oscillator alone is not enough to get the full insight into the market, so don’t get its signals wrong. Use AO with other trading tools, especially the ones measuring asset price and volumes - it will allow you to analyze both historical performance and traders’ current sentiments.