The Awesome Oscillator is one of Bill Williams’ fine creations. It is a simple yet effective momentum indicator that can be a valuable addition to your strategy.
Here we’ll use it together with a moving average to fine-tune our trend following entries.
The complete strategy can be downloaded in the Free Strategies section.
Like the MACD, the Awesome Oscillator (AO) is a momentum indicator that measures the difference between two moving averages.
It is calculated as follows:
Williams recommended the 5 and 34-period simple moving averages, though you are free to optimize these if you wish.
Since the 5-period moving average reacts faster than the 34-period moving average, oscillator values above 0 indicate bullish momentum, while values below 0 indicate bearish momentum.
The AO is available in MT4 by default, under the Bill Williams folder.
Green bars indicate the oscillator is rising, while red bars indicate it is falling.
Momentum often leads price. As shown above, the AO does a decent job at predicting price reversals.
How Do Traders Use the Awesome Oscillator?
I’ll demonstrate the two most common uses of the oscillator.
1. Zero Line Crossover
When the AO crosses above the zero line, it indicates a transition from bearish to bullish momentum, and long trades can be entered.
Conversely, when the AO crosses below the zero line, short trades can be entered.
Like other moving average crossover signals, a large number of false signals will be generated when the market is choppy, likely leading to a string of losses.
Nonetheless, let’s test a simple trend following strategy consisting solely of these entry conditions. A 150-pip stop loss and trailing stop will be added.
As usual, the strategy was quickly programmed in AlgoWizard.
For data, we’ll use the hourly USDCHF over the past 10 years.
Those results are surprisingly good for such a basic strategy. Let’s see whether the second method can produce better results.
2. Saucer Strategy
This strategy is so-called because of the shape it forms on the oscillator chart.
The entry conditions for longs are as follows:
- The AO is above 0, and remains above 0 while the following conditions are met
- There are two consecutive red bars, with the second bar shorter than the first
- The third bar is green
Entry conditions for shorts are symmetrical. Long/shorts will entered at the open of the fourth bar.
An example of a long signal is shown below.
Apparently this strategy attempts to capture trend continuations after a brief consolidation. I programmed the second method and repeated the backtest above.
Yikes! Despite being more specific, these entry conditions actually yield far worse results.
Perhaps this is because the saucer pattern fails to take the longer-term trend into consideration.
Since the simple zero crossover method works better, let’s use that moving forward.
Adding Trend Detection
Momentum indicators like the AO are great for detecting changes in short-term momentum, but what about the longer-term trend?
In trend following, it’s always best to swim with the tide, so let’s only open trades that are aligned with the longer-term trend.
There are countless methods to identify trend direction. In the strategy development section, I compared closing prices with an exponential moving average and a Donchian channel midpoint.
Here we’ll use something different — the slope of a 100-period simple moving average.
If the simple moving average has been rising for 3 consecutive bars, we’ll consider the market to be in an uptrend. Conversely, if it has been falling for 3 consecutive bars, the market is in a downtrend.
This additional trend filter was added to AlgoWizard as follows:
With this additional trend filter, here’s an example of a short being triggered in MT4.
There isn’t a dramatic improvement in long-term backtest results, but consistency is much better. Stagnation has dropped from 1463 to 624 days.
The Awesome Oscillator is a simple and effective tool for detecting changes in short-term momentum. I recommend adding a trend filter to trade in the direction of the longer-term trend.
Another popular way to use the oscillator is to look for divergence between price and momentum. Detecting a divergence pattern using an algorithm can be cumbersome, however. Pattern recognition is one of the more challenging aspects of algorithmic trading.
Is the Awesome Oscillator better than the MACD? It’s difficult to produce a conclusive answer without running a slew of backtests across a range of markets and strategies.
The MACD has an additional signal line that is a 9-period EMA of the main line. This additional line may help generate more entry conditions, so perhaps the MACD has an edge in that regard. Otherwise, I think it boils down to personal preference. Both indicators are conceptually similar.
As usual, the completely strategy can be downloaded in the Free Strategies section.
Have you found an awesome way to use the Awesome Oscillator? Let me know in the comments!