Trading the Ultimate Oscillator
It is important to note that overbought readings are not necessarily bearish. Securities can become overbought and remain overbought during a strong uptrend. In the same fashion, oversold readings are not necessarily bullish. Securities can also become oversold and remain oversold during a strong downtrend.
A word of caution; in a trending market the Ultimate Oscillator overbought and oversold conditions can persist. Know what the market condition is, and look for a confirming signal, like the doji signal in our last two trades.
Ultimate Oscillator Divergences
Divergence occurs when the direction of the price trend and the direction of the indicator trend are moving in the opposite direction. This signals that the direction of the price trend may be weakening as the underlying momentum is changing.
There are two types of divergence:
• Positive or bullish divergence: Positive divergence occurs when the indicator is trending upward while the security is trending downward.
• Negative or bearish divergence: Negative divergence gives a bearish signal as the underlying momentum is weakening during an uptrend.
Divergences should never be taken as a standalone signal, traders should wait for confirmation to signal actual reversal.
Positive Divergence is confirmed with a break of resistance on the price chart and the Ultimate Oscillator above 50. Bearish Divergence is confirmed with a break of support on the price chart and the Ultimate Oscillator below 50.
• A bullish divergence occurs. This is when the security’s price makes a lower low that is not confirmed by a lower low in the oscillator.
• During the bullish divergence, the oscillator falls below 30.
• The oscillator then rises above the highest point reached during the span of the bullish divergence. This is the point at which you buy.
Sell short when:
• A bearish divergence occurs. This is when the security’s price makes a higher high that is not confirmed by a higher high in the oscillator.
• During the bearish divergence, the oscillator rises above 50.
• The oscillator then falls below the lowest point reached during the span of the bearish divergence. This is the point at which you sell short.
Once you have entered a position, you will exit in one of the three following manners:
• Exit on an opposite signal occurring. You would also be reversing to the short side.
• Go flat, not reversing, when the Ultimate Oscillator rises above 70%.
• Once long, close out your position going flat any time the index falls below 45 after having risen above 50. This is your stop loss.
• Exit on an opposite signal occurring. You would also be reversing to the long side.
• Go flat, not reversing, when the Ultimate Oscillator falls to 30 or less.
• Once short, close out your position by going flat any time the index rises above 65. This is your initial stop loss.
Google (GOOG) was making higher highs this past spring, but the Ultimate Oscillator was making a lower low (see “Googling short,” above). During the bearish divergence, the Ultimate Oscillator rises above 50. The oscillator then falls below the lowest point reached during the span of the bearish divergence as shown by the red arrow. This is the point at which you sell short; also price is confirming with the formation of a bearish engulfing pattern. This is how the power of divergences can be used by a trader to get maximum profit out of his trades.
The Ultimate Oscillator is a momentum oscillator that incorporates three different timeframes. Traditional signals are derived from bullish and bearish divergence, but chartists can also look at actual levels for a trading bias. This usually works better with longer parameters and longer trends. For example, the Ultimate Oscillator (20, 40, 80) and price trend favors the bulls when above 50 and the bears when below 50. It is important to use the Ultimate Oscillator with other technical analysis tools like RSI, Bollinger band, volume and support/resistance lines.