Why is the Ultimate Oscillator important for traders and analysts?
The ultimate oscillator is considered an important technical momentum indicator because it seeks to provide more reliable indications of market trend and momentum by calculating momentum using three different time frames.
The ultimate oscillator was developed by noted chartist Larry Williams in an attempt to create a momentum indicator less prone to generating false trading signals. Williams' solution was to create an oscillator that evaluates the strength of price movement as it appears across different time frames. This is a logical approach since traders are familiar with the fact that what looks like a significant price movement on, for example, the hourly time frame may be insignificant when viewed in relation to the daily time frame. The ultimate oscillator gives primary weight to the shortest time frame, so as to give the earliest possible indications of trend change, but filters such indications with data from two longer time frames, each one double the length of the previous time frame considered. Other analysts adjust the time frames used, so instead of calculating the indicator based on four-, eight- and 16-hour charts, the time frames of one-hour, four-hour and daily might be utilized. Overbought and oversold conditions are indicated by readings above 70 or below 30, respectively.
The main signals that traders and analysts look for from the ultimate oscillator are those of divergence, since the indicator was specifically designed to make such signals more reliable than divergence indications from more common oscillators such as the relative strength index (RSI) or the stochastic oscillator. A buy signal is generated when all of the following conditions are met:
• First, there is a bullish divergence between price and the oscillator (price makes a new low, but the oscillator does not make a corresponding new low).
• The bullish divergence occurs with an ultimate oscillator reading of less than 30. This indicates oversold conditions in a market and provides confirmation of the basic divergence signal.
• The oscillator rises to a higher level than the high of the time period during which the bullish divergence originally occurred.