What Is Derivative Oscillator

The Derivative Oscillator is a technical indicator that applies a moving average convergence-divergence (MACD​) histogram to a double smoothed relative strength index (RSI) to create a more advanced version of the RSI indicator.

Breaking Down Derivative Oscillator

The Derivative Oscillator was developed by Constance Brown and published in the book Technical Analysis for the Trading Professional. The technical indicator is a more advanced version of the relative strength index (RSI) that applies moving average convergence-divergence (MACD) principles to a double-smoothed RSI indicator. The indicator is derived by computing the difference between a double-smoothed RSI and a simple moving average. The indicator's intent is to provide more accurate buy and sell signals than the standard RSI calculation. 

Derivative Oscillator Usage

The Derivative Oscillator is used in the same way as the MACD histogram. Positive readings are considered bullish, negative readings are considered bearish, and crossovers above and below the zero line signal indicate potential buying and selling opportunities. Traders may also look for divergence or convergence with the security’s price, which could be an indication of an upcoming reversal in the prevailing trend. This happens when the indicator falls and price rises, or when price falls and the indicator continues to rise.

Traders should consider using the Derivative Oscillator in conjunction with other forms of technical analysis, including lagging indicators and chart patterns.

Derivative Oscillator Example

CHART COURTESY: TC2000

The Derivative Oscillator issues three types of signals while Apple churns through mostly bullish price action in the first half of 2018. The first buy signal comes in early February when the histogram posts a double bottom and contracts toward the "zero" line. The stock bottoms out on February 9th and races higher, gaining 30-points in the next three weeks. The indicator crosses the zero line during the ascent, setting off a secondary buy signal, confirmed by continued bullish price action. However, it tops out at least two weeks ahead of price, highlighting the limitation of using this indicator without confirmation from price action and other technical measurements, including pattern recognition and Fibonacci retracement ratios..

An April bullish crossover above the zero line tops out in early May while price continues to ascend into early June, calling into question the noise level of the 14-5-3-9 settings. Like other leading indicators, the Derivative Oscillator is highly sensitive in shorter time frames, suggesting that market technicians review a wide band of settings before deciding on the best match with the current trading or investment stye.