How to Use Leading Indicators (Oscillators) to Identify Trend Reversals
“The End is Near!” is not just a saying for someone on the street who wants you to believe that the end of the world is upon us. Rather, this is also a signal that you can get from a leading indicator (also called an oscillator) regarding the potential end of a trend that you have seen in the market.
If the trend is coming to an end, you definitely want to know that, and some of your oscillator indicators may provide the perfect indication that this is about to happen if you know what to look for.
Slowing Momentum
The theory behind the oscillator indicators is that as momentum in a currency pair slows it is an indication that there are few buyers or fewer sellers (depending on the direction of the trend) than there were before.
Slowing momentum may be a sign that whichever side had control over the trade before is beginning to lose its grip on it. That could mean that the current trend is ending and that a new trend may begin to take shape.
Indicators That can be used for This Purpose
There are many indicators that you can use as oscillators for trying to figure out when a trend is coming to an end and/or reversing.
Examples include:
- Williams %R
- Stochastic
- Parabolic SAR
- Relative Strength Index (RSI)
Any of these can be hugely valuable to you in terms of determining where the momentum is in a trade, or if that momentum exists at all. If the momentum begins to wane, then it may be time to take your trade in a different direction.
What you are always looking for when it comes to these indicators is if they are signalling that the pair is overbought or oversold. If the indicator is trying to tell you that something is overbought when it had been trending up before, then perhaps the momentum is finally dying down enough that the trend is going to change direction.
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At the same time, if the indicators say that the pair is oversold when it had been trending down before, then maybe the sellers are finally losing steam on that trade.
Take a look at the chart below, where we’ve overlaid three oscillators, for an example of when the stars may be aligning and giving you corroborating signals:
Whatever the case may be, you need to look at your oscillators for early signs that something is changing in the market.
However, you do NOT want to rely on them so much that it blinds you to other possibilities. That is to say that you do not want to look only at the oscillators to the extent that you block out fundamental data and other pieces of information that could contradict what the oscillators say. Always remember, the oscillators are built to be very reactive to data that has recently come into the market.
Sometimes, that data may provide an incorrect reading on what the situation really is, and that is not information that you want to trade on.
Sometimes, the indicators will give you mixed signals — in which case, you might want to check other data, or hold off on the trade.
See below an example of mixed signals:
Ultimately, don’t forget to use multiple means of determining when a trend may be about to end. Start with the oscillators if you want, but don’t forget to check on chart patterns and other tools, as well. This may prove highly useful to you going forward.
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