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what is derivatives oscillator and its uses ?

Introduction

The history of technical analysis of financial trends can be traced back for centuries. In Europe, Joseph de la Vega began observing the Dutch financial markets in the 17th century. The Candlestick pattern was developed in 18th century Japan by Homma Munehisa. In the early 20th century, Charles Dow observed the American stock market, which later led to the formulation of the Dow Theory. Richard W. Schabacker later continued Dow’s work. The book Technical Analysis of Stock Trends, now considered one of the seminal works in financial theory, was published by Robert D. Edwards and John Magee in 1948. George Lane developed the first accurate technical analysis indicator in the 1950s. Since then, there have been newer developments, including the RSI oscillator, that now play a central role in financial markets.

What is a Derivatives oscillator?

A derivatives oscillator is a trading indicator used to determine the market fluctuations of Derivatives. It is essentially a more advanced form of the relative strength indicator (RSI) that applies moving average convergence divergence (MACD) principles to a double smooth RSI. Constance Brown developed it in her book Technical Analysis for the Trading Professional.

How is the Derivatives oscillator derived?

The Derivatives oscillator is calculated in the following steps:

  • First, the 14 periods RSI, double smoothed with moving averages, is calculated.
  • The first RSI is expressed as RSI = Average Gains/Losses.
  • That is followed by applying an exponential moving average to the RSI. It is expressed as Smoothed RSI = EMA (RSI, n1), where n1 is a bar period of EMA.
  • The EMA has applied again to the now smoothed RSI. It is expressed as Double Smoothed RSI = EMA (Smoothed RSI, n2), where n2 is a bar period of EMA.
  • The MACD is derived by subtracting 12 periods EMA from 26 periods EMA and applied to the double smoothed RSI as a signal line, expressed as Signal Line = SMA (Double Smoothed RSI, n3).
  • Finally, the Derivative oscillator is calculated by subtracting the double smoothed RSI and its signal line, expressed as Derivative Oscillator = Double Smoothed RSI - Signal Line.

Usage of Derivatives oscillator

  • Derivatives oscillator is simple to use.
  • When the oscillator shows an ascending value, from negative to positive, it is then interpreted as the signal for using bullish strategies.
  • When the oscillator shows a descending value, positive to negative, it is then interpreted as the signal for using bearish strategies.
  • The oscillator can also determine the strength of a trend by looking at the magnitude of its positive or negative value.

Limitations of Derivatives oscillator

Limitations of the Derivatives oscillator are as follows:

  • The Derivatives oscillator can show a false positive wherein it signals a possible reversal of a trend, but that reversal never happens.
  • The Derivatives oscillator works on past data. It does not account for real-time data. Thus, the oscillator does not provide a very accurate predictive value.

Conclusion

The Derivatives oscillator resembles a formidable instrument for analysing financial trends. However, its reliance on past data and inability to account for the present-day makes it somewhat limited. Thus, traders may choose to work with more than one oscillator, combining the Derivatives oscillator with others for more sophisticated trend analytics. Ultimately, the Derivatives oscillator resembles a powerful analytical tool. 

Disclaimer

ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.

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