What Is a Stock Oscillator?
A stock oscillator is an equation or software program used by traders to help them decide when to buy or sell a given stock. It works by identifying trends in a stock’s price along with other metrics, using that data to help determine whether the stock is overbought — making it a good time to sell it — or oversold, in which case it might be a good time to buy.
Investors typically use oscillators at times when the trend for a stock’s price is unclear, either because it’s in a sideways trading pattern, or because the markets themselves are choppy. An oscillator will show underlying trends in other quantifiable aspects of the stock, such as its buying or selling volume, which may indicate if the stock is likely to move up or down in the near future.
Investors may have access to oscillators through their brokerage account or trading programs. Because oscillators are mathematical, it’s even possible for savvy investors to program them directly into a spreadsheet.
Stock Oscillators and Technical Analysis
Stock oscillators are valuable tools in technical analysis, an approach taken by investors to try to forecast the ways a stock might perform based on its current data and past movements. (Though it’s worth remembering that past performance is no guarantee of future success or failure.)
As a strategy, technical analysis involves looking at a wide range of data and indicators, such as a stock’s price and trading volume, to locate opportunities and risks.
But technical analysis typically doesn’t involve researching the underlying companies, their industries, or any macroeconomic trends that might drive the success or failure of those underlying companies. Rather, it solely analyzes the stock’s performance to find patterns and trends.
As such, these tools are mostly used by short-term traders who plan to hold onto a stock for days or weeks, rather than long-term investors who plan to hold a stock for periods of years.
Recommended: 5 Bullish Stock Trend Indicators
How Do Stock Oscillators Work?
While every oscillator differs, they all tend to identify a normal range for a given stock, using specific criteria to determine if the stock is overbought or oversold based on that range.
Oscillators can help identify buying or selling opportunities. But they can also mislead investors if a stock undergoes a price breakout, which is when an event occurs that effectively resets the trading range of a stock higher or lower.
During a breakout, an oscillator may show that the stock is overbought or oversold for a long period of time. For this reason, many traders consider oscillators best used in sideways or choppy markets.
Types of Trading Oscillators
There are a number of different types of trading oscillators. Here’s what to know about them.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) works by taking measurements of a stock’s recent price changes to determine if it’s overbought or oversold. It’s a popular tool for investors looking for entry and exit points of a given stock position.
The RSI measures the speed and size of a stock’s price movements, and calculates the momentum using the ratio of higher closing prices to lower closing prices. In this oscillator, stocks which have more frequent or larger positive changes receive higher scores. Investors typically chart RSIs over a 14-day timeframe, and rate stocks on a scale from 0 to 100, though they may create custom timeframes.
The oscillator selects a “horizontal channel,” which is a common RSI score for a stock, then marks out price bands above and below that band at which the stock may be considered overbought or oversold.
Moving Average Convergence/Divergence (MACD)
The MACD is an oscillator traders use to understand the momentum of a given stock. It uses the moving average of a stock to determine where a stock is trading over a set period of time. Most investors prefer 12-day and 26-day time spans for their MACDs, but they can also create their own custom MACD measurements with time spans that better fit their own particular trading strategies.
The MACD compares the moving average of the short- and long-term moving average to see if those averages are getting closer (converging) or farther apart (diverging).
If the MACD of a given stock is positive, that means its short-term average is higher than its long-term average, which indicates that the stock’s price is on an upswing. A higher MACD indicates more pronounced momentum in that upswing. On the other hand, a negative MACD indicates that a stock is trending downward.
Recommended: What is MACD?
Commodity Channel Index (CCI)
The CCI is an oscillator investors use to spot price extremes and possible price reversals, and to understand the strength of price trends for commodities, currencies, and stocks. The CCI measures the variation of a security’s price from its statistical mean.
The CCI assigns scores that tend to fall between +100 and -100. CCI scores over +100 mean that a stock may be overbought, while scores under below -100 indicate that a stock may be oversold.
A stochastic oscillator, or “sto indicator,” compares a stock’s average price levels to its current price levels to determine if a stock is overbought or oversold.
Specifically, a stochastic oscillator compares a stock’s closing price to a range of the security’s highest and lowest prices over a period of time that the trader can set. By changing the time frame of the oscillator, traders can adjust its sensitivity to recent market fluctuations.
Pros of Using Oscillator Indicators
There are a number of potential benefits to using oscillator indicators.
• Using multiple oscillators may help investors better understand how a particular stock is trading.
• Oscillators may provide useful alerts that a stock is nearing a price at which an investor may consider buying or selling it.
• Stock oscillators may be highly effective in helping investors identify overbought or oversold conditions in a specific stock.
• Oscillators may be highly effective tools in sideways or choppy markets, where a stock’s trading price remains within a fixed range.
Cons of Using Oscillator Indicators
There are also potential drawbacks to using oscillator indicators.
• While oscillators can be effective in helping investors identify overbought or oversold conditions in a specific stock, whether a stock is overbought or oversold is not necessarily a clear signal to buy or sell it.
• In strong bull or bear markets, an oscillator signal that a stock is overbought or oversold may be misleading.
• Oscillator signals only offer stock price information, and not the bigger picture of what’s happening with the company or its industry.
Stock oscillators are one set of tools in technical analysis, which also employs close reading and interpretation of charts, as well as other technical indicators. Oscillators may help investors determine if a stock is overbought or oversold, even if the price of a stock isn’t giving clear indications.
For investors looking to build their portfolio themselves, SoFi Invest® offers an active investing solution that allows you to choose your stocks, ETFs, and other assets. For those who prefer a less hands-on approach, SoFi Invest also offers an automated investing solution tailored to your goals and personal risk threshold.
Photo credit: iStock/svetikd
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Third-Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected] Please read the prospectus carefully prior to investing. Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.