Bill Williams is a well-known figure in the development of technical indicators. For example, the Bill Williams Gator Oscillator and the Alligator indicator come from him. His developments often go back to chaos theory. This theory can be described simply with the assumption that there is a structure behind every natural chaos, provided that this chaos is broken down into its individual parts. Among other things, the fractal indicator is based on this assumption.
The Awesome Oscillator (AO indicator) is, however, an indicator that should determine the momentum of a price movement. It is calculated quite simply, by the
- difference between the 34- and 5-period moving average (MA) of the price.
Accordingly, buy and sell signals identifies when the two averages cross.
- A buy signal is generated if the MA with the short period crosses the MA with the longer period upwards and vice versa.
The exact calculation of the AO indicator is as follows:
AO = (5 period average of (high + low) / 2) - (34 period average of (high + low) / 2)
Interpretation of the AO indicator
At first glance, the interpretation of the AO indicator is quite simple. The oscillator is displayed in the form of a histogram. Rising trends in the course are shown with green bars and falling trends with red. Let's look at that in the EUR / USD currency pair rate.
As it looks, the AO indicator pretty much follows the course of the exchange rate. Therefore, there is no advantage in advance over a simple set-up analysis of the course. The AO indicator should indicate how strong the trend is. This means that weak trends should be shown in the indicator, since the strength in the course itself cannot always be identified. On closer inspection it becomes clear that this can only be partially achieved.
The AO indicator has a level with the zero line that indicates clear trend strength. If the zero line is overcome upwards, caution should be exercised with put options because the upward pressure is greater.
In the chart shown for the selected period, such zero line crossings occurred five times (circled areas). The signal was clear the first time, showing that the existing downtrend is at risk. There was a dynamic upward movement, although not of long duration.
The second crossing of the zero line indicated that the downward trend would continue, but would have been a false signal because the price turned up again shortly afterwards. The fourth signal was not a false signal, but the trend did not last long either, so medium-term investors should not have relied on it too much.
It can therefore be summarized briefly: The AO indicator also has its weaknesses, namely at long-term sideways phases, since it only recognizes the strength of a short-term trend - based on the set time base of the chart. This weakness has to be avoided by optimization, which we will do with the AO indicator in the next article on strategy development.
However, this applies to almost every indicator. Therefore, the general question is not whether an indicator can be used as the sole tool, but whether it can be optimized well.
Conclusion: Can the AO indicator be optimized?
The AO indicator or awesome oscillator can be optimized in various ways. For example, one could choose the period settings for the averages differently, change the time base of the chart or use a filter indicator. But you could also rely on the indicator to be reversed instead of acting in a trend order.
If you look at the upper chart, you can see that a strong reversal was often accompanied by the abrupt change between red and green bars, But caution is also required here. The first signal would have indicated a strong reversal, but the trend could not establish itself. Here, too, the sideways phase becomes visible as the indicator's weakness. However, the false signals are significantly less than with the trend following. In the next post we will approach the weakness in sideways phases.
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