What is the Ultimate Oscillator?
The Ultimate Oscillator is a technical indicator that was developed by Larry Williams in 1976 to measure the price momentum of an asset across multiple timeframes. By using the weighted average of three different timeframes the indicator has less volatility and fewer trade signals compared to other oscillators that rely on a single timeframe. Buy and sell signals are generated following divergences. The Ultimately Oscillator generates fewer divergence signals than other oscillators due to its multi-timeframe construction.
- The indicator uses three timeframes in its calculation: seven, 14, and 28 periods.
- The shorter timeframe has the most weight in the calculation, while the longer timeframe has the least weight.
- Buy signals occur when there is bullish divergence, the divergence low is below 30 on the indicator, and the oscillator then rises above the divergence high.
- A sell signal occurs when there is bearish divergence, the divergence high is above 70, and the oscillator then falls below the divergence low.
The Formula for the Ultimate Oscillator is
Ultimate Oscillator=[4+2+1(Average7×4)+(Average14×2)+Average28]×100where:Buying Pressure (BP)=Close−min(Low,Prior Close)True Range (TR) =max(High,Prior Close)−min(Low,Prior Close)Average7=∑p=17TR∑p=17BPAverage14=∑p=114TR∑p=114BPAverage28=∑p=128TR∑p=128BP
How to Calculate the Ultimate Oscillator
- Calculate the Buying Pressure (BP) which is the close price of the period less the low of that period or prior close, whichever is lower. Record these values for each period as they will be summed up over the last seven, 14, and 28 periods to create BP Sum.
- Calculate the True Range (TR) which is the current period's high or the prior close, whichever is higher, minus the lowest value of the current period's low or the prior close. Record these values for each period as they will be summed up over the last seven, 14, and 28 periods to create TR Sum.
- Calculate Average7, 14, and 28 using the BP and TR Sums calculations from steps one and two. For example, the Average7 BP Sum is the calculated BP values added together for the last seven periods.
- Calculate the Ultimate Oscillator using the Average7, 14, and 28 values. Average7 has a weight of four, Average14 has a weight of two, and Average28 has a weight of one. Sum the weights in the denominator (in this case, the sum is seven, or 4+2+1). Multiply by 100 when other calculations are complete.
What Does the Ultimate Oscillator Tell You?
The Ultimate Oscillator is a range-bound indicator with a value that fluctuates between 0 and 100. Similar to the Relative Strength Index (RSI), levels below 30 are deemed to be oversold, and levels above 70 are deemed to be overbought. Trading signals are generated when the price moves in the opposite direction as the indicator, and are based on a three-step method.
Larry Williams developed the Ultimate Oscillator in 1976 and published it in Stocks & Commodities Magazine in 1985. With many momentum oscillators correlating too heavily to near-term price movements, Williams developed the Ultimate Oscillator to incorporate multiple timeframes to smooth out the indicator's movements and provide a more reliable indicator of momentum, with fewer false divergences.
False divergences are common in oscillators that only use one timeframe, because when the price surges the oscillator surges. Even if the price continues to rise the oscillator tends to fall forming a divergence even though the price may still be trending strongly.
In order for the indicator to generate a buy signal, Williams recommended a three-step approach.
- First, a bullish divergence must form. This is when the price makes a lower low but the indicator is at a higher low.
- Second, the first low in the divergence (the lower one) must have been below 30. This means the divergence started from oversold territory and is more likely to result in an upside price reversal.
- Third, the Ultimate oscillator must rise above the divergence high. The divergence high is the high point between the two lows of the divergence.
Williams created the same three-step method for sell signals.
- First, a bearish divergence must form. This is when the price makes a higher high but the indicator is at a lower high.
- Second, the first high in the divergence (the higher one) must be above 70. This means the divergence started from overbought territory and is more likely to result in a downside price reversal.
- Third, the Ultimate oscillator must drop below the divergence low. The divergence low is the low point between the two highs of the divergence.
The Difference Between the Ultimate Oscillator and Stochastic Oscillator
The Ultimate Oscillator has three lookback periods or timeframes. The Stochastic Oscillator has only one. The Ultimate Oscillator doesn't typically include a signal line (one could be added), while the Stochastic does. While both indicators generate trade signals based on divergence, the signals will be different due to the different calculations. Also, the Ultimate Oscillator uses a three-step method for trading divergence.
Limitations of Using the Ultimate Oscillator
While the three-step trading method for the indicator may help eliminate some poor trades, it also eliminates many good ones. Divergence is not present at all price reversal points. Also, a reversal won't always occur from overbought or oversold territory. Also, waiting for the oscillator to move above the divergence high (bullish divergence) or below the divergence low (bearish divergence) could mean poor entry point as the price may have already run significantly in the reversal direction.
As with all indicators, the Ultimate Oscillator shouldn't be used in isolation, but rather as part of a complete trading plan. Such a plan will typically include other forms of analysis such as price analysis, other technical indicators, and/or fundamental analysis.