The Power of Momentum,

Divergence & Convergence

This article will discuss the Awesome Oscillator and how you can use
this multiple time frame trading to your advantage to make more pips!
But before we explain the ins and outs of this indicator, we would like to ask
you whether you use a lower case indicator? And if so, which one? Please
share with us at the bottom of the article!
Bill Williams Awesome Oscillator
The Bill Williams Awesome Oscillator (AO) is a technical analysis indicator
created by Bill M. Williams, a trader, and educator who has decades of
experience. The indicator is a price based indicator which is shown at the
bottom (or above) of the main price chart.
The indicator is designed to show current market momentum and has
similarities to another well-known momentum indicator, the MACD, The AO is
also showed as a histogram and is created using the difference between the
34 period and 5-period simple moving averages of the bars midpoints: (High +
Low)/2.
As a warning though, a trader should realize that all indicators are lagging. For
more information on Forex indicators and tips.
The AO bars, contrary to the typical MACD, have two colors. Green indicates
that the current bar is higher than the preceding bar. Red indicates that the
current bar is lower than the preceding bar.
How to use it
The oscillator can be used in these ways:
1) The change in colors identifies areas and candlesticks when the momentum is
losing, maintaining, or regaining its thrust in the current direction.
2) As with other oscillators, when the histogram bars cross the zero line the
momentum of the price action is changing on the time frame of your chart. When
crossing from above the zero line to below the zero line, the price action
momentum has turned bearish. When crossing from below the zero line to above
the zero line, the price action momentum has turned bullish.
3) The indicator can be used to measure divergence and convergence. When
the price reaches an extreme and the AO makes a top or bottom as well, the
strength of the move can be compared to the strength of the previous moves.
When the price makes a higher high or lower low, it is useful to check whether
the AO histograms are also making a similar higher high and lower low. If yes,
the strength and momentum of the move support price action. If not, then it
could indicate that the strength and momentum of the move are fading and
it could signal the first sign of a potential turn around.
Be careful and only use the AO with other confirmations as the divergence
could only cause a small correction, after which price continues with the
established trend. In those cases, you could see double or triple divergence
before a turnaround indeed happens.
If a trader sees divergence, one method is to wait for the color of the
histogram bars to change. For example in a bull market wait for the bar color
to turn red. In a bear market, wait for the bar color to turn green.
4) The indicator can be useful as well in counting the Elliot Waves. The
histogram measurement at the end of a Wave 1 normally is close to zero line
and typically traveled quite a distance to cross it. During the Wave 2
correction the histogram bars usually retrace and re-enter the same zone, but
very shallow. Wave 3 sees a very strong momentum pushing the AO to a new
extreme far above the Wave 1 top. Wave 4 should see the AO retrace back to
the zero line either remaining in the same zone or slightly crossing. Wave 5
then sees a new burst in the same direction was Wave 3, but the momentum
dies out and although price makes a new high or low, the AO peak usually
does not.
Checklist
A useful tool for analyzing the AO could be a checklist where one analyzes all 4 points to
make a conclusion.
1) Currency pair
2) Timeframe(s)
3) Position of the AO above or below the zero line
4) The color of the AO histogram
5) Compare the extremes of price (tops/bottoms) with the extremes of the AO for
divergence
6) Judge whether the AO matches an EW
Of course, a currency pair that has green bars above the zero line with no divergence has a
strong momentum behind it. Looking for buying opportunities on that chart or on a lower chart
makes sense. Looking for shorts would logically not be advisable. Of course always use other
methods to establish entries, exits, and take profits. But with keeping an eye on the
momentum, a trader will not lose track of the direction.
Multiple time frame trading
One method that allows for more context is to use multiple time frame trading.
When looking at two, three or four-time frames, the trader can judge and
analyze the meaning of price and the histogram bar of all time frames relative
to each other. This allows a trader to see that a negative AO movement in the
lower zone on the 1-hour chart could only signal a retracement of the AO
back to the zero line on the 4-hour chart.
For example, a currency that has green bars above the zero line on two time
frames most likely signals significant bullishness. A currency that has mixed
readings on two-time frames could indicate caution.
Retracements
The AO can also be a strong weapon in catching a Fibonacci retracement
level. Instead of buying a particular Fib retracement level with a market order
at the Fib. A trader could opt for a confirmation of the AO and first await a
change of the AO histograms color back into the desired direction.
This is especially useful when a higher time frame is set up for an up move but is
currently making a retracement which is evident by the AO retracing back to
the zero line. When the AO approaches the zero line, the trader could monitor
a lower timeframe to check for:
a) Divergence, multiple or even triple divergences
b) A Fibonacci retracement target or retracement level close by
c) A change of the histogram color in the direction of the trend on the
higher time frame