Last Updated on 13 April, 2021 by Samuelsson
Ultimate Oscillator is a momentum indicator that integrates three different times periods within one value. By considering different time periods and using an elaborate decision mechanism, the tool hopes to reduce the sensitivity of momentum oscillators to recent data and instead focus better on long trends. Investors, especially those that dabble in active investment, will do well to use Ultimate Oscillator in their investment decision making.
What is the Ultimate Oscillator?
The Ultimate Oscillator is a technical indicator that is used to maximize returns from price momentum analysis. It is an oscillator, like RSI (relative strength indicator), that guides the investor in better timing their exits and entry into the market, to maximize the returns on their investments. However, unlike other momentum oscillators, the Ultimate Oscillator uses three different time frames before generating the buy or sell signals within the market. Taking three different time frames allows the oscillator to integrate short-term and long-term analysis into one measure.
Like all momentum indicators, an Ultimate Oscillator has a value between 0-100. An Ultimate Oscillator will generate buy and sell signals on the basis of divergences between the oscillator and the price candles. Compared to other oscillators, this measure generates fewer buy and sell signals. The following topic will guide the investor on the structure of Ultimate Oscillator and its use in the market.
Who created the Ultimate Oscillator?
The Ultimate Oscillator was created by Larry Williams in the ’70s. The ’70s were the heyday for the introduction of new technical indicators that have since become an indispensable part of any good investor’s toolbox. Larry was one of the best stocks and commodity traders in the ’70s. He shared his intellectual baby with the “World Stocks & Commodities Magazine” in 1985. Since then, Ultimate Oscillator has gained fame as a tool that redeems many bad qualities of other oscillators.
How Does Ultimate Oscillator Differ From Other Indicators?
For those investors that are familiar with momentum oscillators, the Ultimate Oscillator often resembles other oscillators such as RSI and stochastic oscillators, on the surface. However, the Ultimate Oscillator differs from other momentum oscillators in some key ways.
Use of multiple time periods:
First, the Ultimate Oscillator uses three different time periods for its measures instead of one. In contrast, RSI and stochastic oscillator use single time frame measures. This difference allows the Ultimate Oscillator to integrate short term and long-term analysis into one compound measure.
Different buy and sell signals:
Second, even though both the measures use divergence to generate buy and sell signals, the actual markers for buy and sell signals will be different. the Ultimate Oscillator will give different buy and sell signals for the same data because the formulae for Ultimate Oscillator is different as compared to the stochastic oscillator and RSI indicator.
For example, for the RSI indicator, only the absolute value is used to generate the buy and sell signals for the investor. RSI works on the principle of an asset being over-sold or over-bought. If an asset is over-sold, then the market is expected to realize this in a short while and start buying the asset. This will increase the price of an asset. A value of less than 30 indicates the asset is being oversold. Oversold assets are expected to retain their value and increase in price in the near term. Therefore, values under 30 give a sell signal.
Similarly, with RSI, a value of above 70 indicates that the asset is over-bought. The market is expected to correct this mistake via increased selling. This, in-turn, will decrease the price of the asset. Therefore, above 70 values give a sell signal.
The following description will show that the Ultimate Oscillator uses a different mechanism.
How do we calculate the Ultimate Oscillator values? Does one really need to know the formula for the Ultimate Oscillator?
Investors do not need to understand the calculation for Ultimate Oscillator in order to earn money from it. However, knowing the formula for Ultimate Oscillator will definitely help in comparing it with other measures and understanding the weaknesses of the Ultimate Oscillator.
The Ultimate Oscillator is a compound measure that takes its value from three different time periods. These time periods include the seven, fourteen and twenty-eight-day average values. Furthermore, the calculation also uses the Buying Pressure and True Range values. The following step-by-step guide checklist will detail how the Ultimate Oscillator values are calculated for a given day.
Step 1: Calculate the True Range value for the given day.
The formula for True Range is as following
True Range = Max (High, Prior Close) – Min (Low, Prior Close)
Some readers find the above formula a bit confusing. The same formulae can be restated as following
True Range for a given day = [whichever is bigger] (high or prior close) minus [whichever is lower] (low or prior close]
Note: Having such a formula allows the True-Range to calculate true range even when there are price gaps in the price chart.
Step 2: calculate the buying pressure in the market for every day
Buying Pressure (BP)=Close−min(Low,Prior Close)
Note: “Min” means whichever value is lower.
Step 3: calculation the average values for seven, fourteen and twenty-eight days.
The process for calculating the average is same for different time periods therefore this article will only demonstrate the process for only seven days.
Step 3.1: add-up the buying pressure values for the seven days. Mathematically, this is written as
Step 3.2: add-up the True Range values for the seven days. Mathematically, this can be written as:
Step 3.3 divide the summation sum of buying pressure with that of the true range to get the period-average values for seven days. Mathematically, this average can be represented via the following formulae
Such a formula can also be replicated for 14 days and 28 days.
Step 4: calculate the Ultimate Oscillator using the weighted mean of the three-period averages.
Ultimate Oscillator =
How to read and use the Ultimate Oscillator using different strategies?
Reading the Ultimate Oscillator is very similar to reading other oscillators (like RSI). Ultimate Oscillator will have their values between 0 and 100. The investor will look at the trend of the Ultimate Oscillator values as well as their relative position to critical values. These critical values are often 30 for over-sold and 70 for over-bought. However, the actual values change from market to market. The following image shows what an investor will be typically looking for, when they are using the Ultimate Oscillator.
In the above image, one can see the price chart and Ultimate Oscillator below that. The investor will also see the thresholds for over-bought and oversold (purple and green lines).
Strategies to use for the ultimate strength indicator
Now that an investor can read the ultimate strength indicator, they can implement various strategies using this tool. This article will focus on the most common and useful strategy used by investors to maximize their returns.
Ultimate Oscillator Buy and Sellshort Signals
Larry, the creator of the Ultimate Oscillator, came up with this strategy. According to Larry, a decision for a buy or sell signal must be made after looking at three criteria. Before discussing these three criteria, it is pertinent to note that since the decision rules for buy and sell are the exact opposites of each other, therefore the guide will only show the conditions required for sell signals.
Criterion no 1:
There is a bearish divergence between the price and the Ultimate Oscillator. A divergence is simply the price and Ultimate Oscillator moving in opposite directions. The following image shows an example of such a bearish divergence.
Criterion no 2:
The oscillator peak of the bearish divergence must be higher than 70 i.e. the asset must be over-bought. In the image above, the circle shows that the Ultimate Oscillator does indeed cross 70.
Criterion no 3:
The Ultimate Oscillator must get lower than the divergence low. The divergence low in this case the low point between the two highs of the bearish divergence. In the above image the point is marked with a purple line.
Once these three criteria are met, then the investor can be assured that the oscillator is generating a sell signal. The exact opposite would hold true for a buy signal.
What Are the Strengths and Weaknesses of the Ultimate Oscillator?
Better immunity to short-term small price oscillations: – momentum indicators such as RSI are infamous for their sensitivity to short-term price fluctuations. The Ultimate Oscillator corrects this flaw by taking multiple time periods and by using an intricate decision-making mechanism.
Missing out on short-term moves: Despite what the name suggests, there is no such thing as an ultimate tool. Instead of blind faith in any one tool, an investor must realize that every tool has its weakness. After this realization, the natural reaction is to find out about the weaknesses and see if one can come up with ways to counter these weaknesses. Well, one of the weaknesses for the Ultimate Oscillator is that it might miss-out (not generate buy or sell signals) on small moves within the market. This can really become a problem if the investor heavily relies on short-term trading to make their returns.
Ultimate Oscillator is one of the many good things to come out of the 70s and 80s. This technical tool one-ups other momentum oscillators by using elaborate decision-making mechanisms as well as using more than a one time frame. Though the new construct causes Ultimate Oscillators to miss out on some opportunities, yet the benefits far outweigh the costs especially for investors that rely on long-term strategies.