Combining Trend and
Oscillator Signals

Most trading systems fall into two categories. One, the most popular, is the trend-following method, where the signals are oriented toward putting the trader on board long-term trends. The profits acquired during the long-term trends will, hopefully, recover the monies lost during trendless activity. The other category takes advantage of trading ranges, and the trader makes the most money when the market's primary direction is sideways. Here's a trading system that incorporates both approaches to time entry and exit positions.

"Market technicians looking to pinpoint market tops and bottoms have long been fascinated by the cyclical activity of markets. The oscillator, which is the class of indicators used to model the cyclical nature of markets, typically will filter the trend out of prices, leaving only the tradable cycles. In addition, an oscillator is a type of momentum indicator that shows the acceleration and deceleration of markets. When a market has been accelerating upward and then begins to slow, the oscillator levels off, indicating the price action as a market top. Likewise, if a market is accelerating downward and that acceleration slows, then a bottom is indicated by the oscillator leveling off and then rising."

SYSTEM COMPONENTS
"The first component of the trading system is the oscillator. Most oscillators use the difference between price and a moving average, but I am using the linear regression slope function found in SuperCharts."

"Figure 1 shows a weekly closing price of the continuous contract of the yen futures contract with the oscillator plotted in the lower graph."

Figure 1: CLOSING WEEKLY PRICES FOR YEN. The oscillator in the bottom has two lines. The oscillator line is the value of the slope of a five-week linear regression slope function. The trigger line is a 50-week linear regression of the five-week linear regression slope function of the closing prices.

During a trending market, a trend-following indicator will perform better than any other indicator because the signals are designed to put the trader on the correct side of long-term trends.

"As a trader, understanding why various analytical techniques work or don't will help to develop your level of expert knowledge, and that in itself is far more valuable than any machine-learning approach."

Excerpted from an article originally published in the December 1996 issue of Technical Analysis of STOCKS & COMMODITIES magazine. 
© Copyright 1996, Technical Analysis, Inc. All rights reserved.

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