Oscillators typically compare a security's smoothed
price with its price x-periods ago. Larry Williams noted that the value
of this type of oscillator can vary greatly depending on the number of
time periods used during the calculation. Thus, he developed the
Ultimate Oscillator that uses weighted sums of three oscillators, each
of which uses a different time period.
The three oscillators are based on Williams'
definitions of buying and selling "pressure."
Interpretation
Williams recommends that you initiate a trade
following a divergence and a breakout in the Ultimate Oscillator's
trend. The following text sumarizes these rules.
Buy when:
A bullish divergence occurs. This is when the
security's price makes a lower low that is not confirmed by a lower
low in the Oscillator.
During the bullish divergence, the Oscillator
falls below 30.
The Oscillator then rises above the highest point
reached during the span of the bullish divergence. This is the point
at which you buy.
Close long positions when:
The conditions are met to sell short (explained
below), or
The Oscillator rises above 50 and then falls
below 45, or
The Oscillator rises above 70. (I sometimes wait
for the oscillator to then fall below 70.)
Sell short when:
A bearish divergence occurs. This is when the
security's price makes a higher high that is not confirmed by a higher
high in the Oscillator.
During the bearish divergence, the Oscillator
rises above 50.
The Oscillator then falls below the lowest point
reached during the span of the bearish divergence. This is the point
at which you sell short.
Close short positions when:
The conditions are met to buy long (explained
above), or
The Oscillator rises above 65, or
The Oscillator falls below 30. (I will sometimes
wait for the oscillator to then rise above 30.)
Example
The following chart shows Autozone and its Ultimate
Oscillator.
I drew "sell" arrows when the conditions for a sell
signal were met:
A bearish divergence occurred (lines "A") when
prices made a new high that was not confirmed by the Oscillator.
The Oscillator rose above 50 during the
divergence.
The Oscillator fell below the lowest point
reached during the span of the divergence (line "B").
Similarly, I drew "buy" arrows when the conditions
for a buy signal were met:
A bullish divergence occurred (lines "C") then
prices made a new low that was not confirmed by the Oscillator.
The Oscillator fell below 30 during the
divergence.
The Oscillator rose above the highest point
reached during the span of the divergence (line "D").
