Oscillators measure momentum. and are designed to show when an asset is potentially overbought or oversold.
Oscillators work under the theory that as momentum begins to slow, fewer active buyers and sellers are willing to trade at the current price.
Oscillators can help distinguish between reversals and fluctuations.
There are two broad categories of oscillators:
- Centered oscillators that fluctuate above and below a center point or line.
- Banded oscillators that fluctuate between overbought and oversold extremes.
Generally, centered oscillators are best suited for analyzing the direction of price momentum, while banded oscillators are best suited for identifying overbought and oversold levels.
Also, they can give traders an idea of whether the price trend is likely to continue.
The principle behind the momentum indicator is that as an asset is traded, the speed of the price movement reaches a maximum when the entrance of new buyers is at its peak.
When there are no more buyers left, the tendency after the peak is for the price trend to flatten or reverse direction.