trading indicator

Oscillating Indicators Trading Strategies: Statistics, Facts, Evidence And Historical Backtests!

We rank Williams %R as the best oscillating indicator for trading strategies. It’s certainly not the most known nor the most used, but in our humble opinion, our backtests proved Williams %R to be the most stable indicator for almost all of our parameters. It’s not the indicator with the highest return, but it has on average the lowest max drawdown, perhaps the most important criterion for a short-term trader. 

What is an oscillating indicator?

An oscillating indicator is a mean-reverting indicator that moves up and down, often by using bands to indicate oversold and overbought levels. When the readings are high, the security is overbought, and when they are low, the security is oversold.

There are many ways to interpret an oscillating indicator, but we only look at overbought and oversold conditions in this article.

An example of an oscillating indicator is provided below, which shows how the 7-day RSI (the lower pane):

Oscillating indicator
The RSI indicator oscillates between 0 and 100.

The price of the security, in the upper pane, goes up and down, while the indicator in the lower pane reacts to the velocity of the movements of the security. Even though the price in the upper pane sets a new high or low, the indicator doesn’t necessarily set a corresponding high or low. It all depends on the speed of the rise or decline of the price.

Which oscillating indicators do we test?

There is almost an unlimited number of oscillating indicators, but we concentrate on the most popular ones – the one you find below. If you click on the link you can read more about the specific indicator (we will not go into details about each indicator in this article):

There are, of course, plenty of other indicators to choose from. However, we have written about these six specific indicators in separate articles because they are the ones we found to be the best ones. It’s beyond the scope of this article to cover all oscillating indicators, but we believe six indicators are a pretty good sample to choose from!

What is the best time frame for oscillating indicators?

The best time frame for oscillating indicators is a relatively short time frame. However, it’s impossible to define the best time frame for trading. There are no absolute answers, but generally, the best time frame is relatively short. By short, we mean between 2 and 10 days. Anything longer than that we have found to be less efficient and involves substantially bigger max drawdowns.

As a trader, you want to be efficient. By that, we mean a high return on capital in the least amount of time. It’s possible to find inefficiencies in the market but they are normally of short duration. Thus, the time frame has to be relatively short.

How do we rank the best oscillating indicator for trading strategies?

We rank the best oscillating indicator by backtesting to find profitability, reliability, risk, and reward.

Let’s do some backtests to find the best oscillating indicator for trading strategies:

To find the best oscillating indicator for trading strategies, we use trading software (in this case we use Amibroker) and optimize the trading rules. Optimization in trading is a useful tool to check for durability, profitability, and negative skewness, just to name a few examples of optimization’s practical use.

We use the relevant indicator for both the entries and the exits with symmetry. By that we mean the following: if we enter at RSI readings below 30, we exit at readings above 70.

We do the following in our backtests:

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In which market do we rank for the best oscillating indicator?

We rank the best oscillating indicator based on the results we get from the stock market, in this case the S&P 500.

The most traded market is the stock market. Hence, we test by using daily bars on the S&P 500. We use the ETF with the ticker code SPY as a proxy and we test from its inception in 1993 until today.

Oscillating indicators are primarily mean-reverting indicators

Keep in mind that over this time span the S&P 500 has shown mean-reverting properties. Oscillating indicators are primarily mean-reverting and thus we are dependent on this to continue for oscillating indicators to work.

Prior to the 1990s, this was much less the case. Please read our previous articles about mean reversion strategies and trend-following strategies. There are no guarantees that mean reversion will continue working in the future!

Williams %R

We start by testing the Williams %R indicator.

Williams %R fluctuates between 0 to -100 and is somewhat similar to its cousin, the stochastic indicator.

What does the Williams %R measure? It’s an oscillating indicator that reflects the current close relative to the highest high for the lookback period. A high reading is considered overbought, and low readings are considered oversold.

Here is how a 5-day lookback period looks in the S&P 500:

Oscillating indicator - Williams %R
Oscillating indicator – Williams %R

Let’s run an optimization of Williams %R:

The first column is the lookback period, the second column is the entry level, and the third column is the exit level. The results in the table are primarily ranked on profit factor and secondly on the number of trades. We want a high number of trades to ignore most of the noise and randomness.

Clearly, the best result involves a pretty “high” number of days (above 6 at least) and a low entry level but also a low exit level. The latter means that the exit criteria are an easy bar to pass and result in a short holding period (not shown in the table). The average holding period is around three days for all the highest-ranking numbers.

If we pick the second-best strategy with a holding period of 10 days and entry at -90 and exit -80 we get the following equity chart:

Oscillating indicator strategy (Williams %R)
Oscillating indicator strategy (Williams %R)

The blue line in the lower chart shows the drawdowns (which are pretty good by all standards). The only negative years are 2010 and 2018.

Relative Strength Index (RSI)

Let’s switch to perhaps the most popular indicator there is: the Relative Strength Index (RSI).

The RSI is a little bit different than the Williams %R: it measures the magnitude of both gains and losses over a period of n days. It measures the relative strength of the asset compared to the price movement over the determined period. The value of RSI can be a maximum of 100, and the minimum can be zero.

An example of the indicator is shown in the lower pane:

Oscillating indicator (RSI)
Oscillating indicator (RSI)

The 7-day RSI goes up and down, but notice that high and low differs between the price and the indicator.

Let’s make an optimization of the indicator and see how it performs:

The first column is the number of days in the lookback period and the second and third are the entry and exit levels. The rank is primarily on the profit factor and secondly on the number of trades.

Compared to the Williams %R we can see that the patterns seem a bit more random and we don’t see any particular “clusters”.

The equity chart below is a two-day RSI and entry at 10 and exit at 60:

Oscillating indicator strategy (RSI)
Oscillating indicator strategy (RSI)

The strategy performed reasonably well until 2015 but has since then performed poorly. As we can see, the blue line shows that the drawdown was 30% when the Covid-19 hit the markets in 2020. The max system drawdown is higher than for Williams %R.

The Internal Bar Strength Indicator

Let’s go to the next indicator: the Internal Bar Strength Indicator (IBS). This is a “simple” indicator that measures the (close – low) / (high – low) and oscillates between 0 and 1. A value of 0 means the close is equal to today’s low, and opposite, a value of 1 means the close is today’s high.

We optimized the indicator by using a moving average of the IBS:

The first column shows the number of days in the moving average, and the two next columns show the entry and exit criteria. The profit factor is high but the drawdown varies a lot. Also, the number of days (the first column) shows that there are no clusters.

If we use a two-day average and enter when the value closes below 0.3 and sells when it reaches 0.8, we get the following equity chart:

Oscillating indicator strategy (IBS)
Oscillating indicator strategy (IBS)

The graph looks good, but it’s a nasty drawdown during the financial crisis in 2008/09.

Stochastics

The stochastic indicator is an indicator that has two lines: a fast line that is called %K and a slow line which is called %D.

The %K is pretty similar to Williams %R. The %K reads like this if we are using a five-day lookback period:

( close – low(5) ) /( High(5) – low(5) ) * 100.

The %D is a smoothed average of the %K. In this article, we don’t test crossovers of %K and %D but only look at values of %K.

The chart below has both the five-day %K and a five-day RSI in the two lower panes:

Oscillating indicator (stochastics)
Oscillating indicator (stochastics)

The indicators are different, but the visual similarities are striking.

Let’s optimize the stochastic %K:

Again, it’s difficult to see a particular pattern in both the number of days and the level of entry and exit. All in all, the stochastic indicator performs well and has captured most of the important movements of the S&P 500 all the way back to 1993.

The best CAGR was 4 days and 40 and 75 for entry and exit, but the drawdown was pretty big. A two-day lookback period and 10 as entry threshold and 70 as exit showed small drawdowns and great returns. Here is the equity curve:

Oscillating indicator strategy (stochastics)
Oscillating indicator strategy (stochastics)

Bollinger bands

Bollinger Bands were named after its inventor, John Bollinger. The indicator consists of three bands:

  • The middle band is a moving average based on x days (usually an exponential or simple moving average).
  • An upper band x number of standard deviations added to the moving average.
  • A lower band x standard deviations subtracted from the moving average.

Normally, a buy signal happens when the lower band is penetrated, and a sell signal is when the price crosses the middle or the upper bands. For trend-followers, the signal could be the opposite, but that doesn’t work in the stock market.

Below is our optimization of the Bollinger Bands:

The best combinations of the Bollinger Bands are from 6 days up to ten days, but the max drawdown is for all combinations pretty high.

The equity chart below shows 8 days, one standard deviation for entry, and 1.8 standard deviations for exit:

Oscillating indicator strategy (Bollinger Bands)
Oscillating indicator strategy (Bollinger Bands)

The result is good, but Bollinger Bands are the indicator that comes closest to a buy-and-hold strategy with a high exposure time.

WilliamsVixFix

WilliamsVixFix was developed by the famous trader and tax rebellion Larry Williams.

The indicator is a proxy for the real VIX (please read our article about what is the VIX?) and can be used on any ETF, stock, or any financial asset you like or trade.

What does the WilliamsVixFix measure? In plain English it looks back at the highest and lowest quotes over the last n bars:

  1. The high over the last n days and subtract the low of today (or the current bar).
  2. Divide by the highest close of the past n days.
  3. The result is multiplied by 100 to “normalize” the indicator.

The result is a volatility indicator that resembles (visually) the real VIX. An example is provided below showing the similarities between the two:

Oscillating indicator (WilliamsVixFix)
Oscillating indicator (WilliamsVixFix)

Let’s make an optimization by using a 10-day lookback period to better understand if this is a good trading indicator or not (the indicator has quite a few “overlapping” trades). We use the “percentrank” function in Amibroker (also read more about this in the linked article about the indicator):

Like in all our other backtests we sorted the results based on the profit factor and the number of trades. A ten-day lookback period seems best for entry and exits :

Oscillating indicator strategy (WilliamsVixFix)
Oscillating indicator strategy (WilliamsVixFix)

The CAGR is about 8.5% and the strategy is invested about 50% of the time. However, the drawdown is pretty high.

Amibroker code for the best oscillating indicator

If you want to have the Amibroker code for the test we did above (plus the code for all the other free trading strategies), you can order it at this link:

Amibroker is a very powerful tool despite its cheap price. It works both for backtesting and live trading, especially with Interactive Brokers. How you can learn to code, do backtests, and live trading is described in our Amibroker course.

Conclusion

Based on the backtests we did in this article, we would rank the backtested oscillating indicators in the following order:

  1. Williams %R
  2. Internal Bar Strength Indicator
  3. Stochastics
  4. Relative Strength Index
  5. Bollinger Bands
  6. WilliamsVixFix

Williams %R is the best oscillating indicator! But we regard the three on the top as pretty equal.

What do we base this rank on?

We put Williams %R on top because it showed the most stable and solid results around all the different variables. Furthermore, Williams %R is the indicator that had the lowest average max drawdown, one of the most important parameters for a short-term trader.

Oscillating Indicator Glossary

  1. Relative Strength Index (RSI): Measures the magnitude of recent price changes to evaluate overbought or oversold conditions.
  2. Stochastic Oscillator: Compares a closing price to its price range over a given time period to identify momentum and trend strength.
  3. Moving Average Convergence Divergence (MACD): Tracks the relationship between two moving averages of a security’s price.
  4. Bollinger Bands: Consists of a middle band being a moving average, with upper and lower bands providing volatility boundaries.
  5. Average True Range (ATR): Measures market volatility by decomposing the entire range of an asset price for that period.
  6. Commodity Channel Index (CCI): Identifies new trends or cyclical conditions by comparing current prices to average prices.
  7. Momentum Indicator: Measures the speed or velocity of price changes in a security to identify the strength of a trend.
  8. Rate of Change (ROC): Displays the percentage change in price between the current price and the price a certain number of periods ago.
  9. Williams %R: Determines overbought or oversold conditions by comparing the closing price to the high-low range over a period.
  10. Ichimoku Cloud: Provides information about trend, momentum, and support and resistance using five lines plotted on a chart.
  11. Fibonacci Retracements: Uses horizontal lines to indicate areas of support or resistance at the key Fibonacci levels.
  12. Parabolic SAR: Identifies potential reversals in the market price direction of traded goods such as stocks or commodities.
  13. Volume Oscillator: Shows the difference between two moving averages of volume to highlight trends in volume.
  14. Money Flow Index (MFI): Uses both price and volume to measure buying and selling pressure.
  15. On-Balance Volume (OBV): Uses volume flow to predict changes in stock price.
  16. Accumulation/Distribution Line: Assesses the cumulative flow of money into and out of a security to identify trends.
  17. Chaikin Oscillator: Measures the momentum of the Accumulation Distribution Line using the MACD formula.
  18. Gann Angles: Represents a geometric form of technical analysis based on the notion that markets rotate from angle to angle.
  19. Elliott Wave Theory: Predicts market movements by identifying extremes in investor psychology, highs and lows in prices, and other collective factors.
  20. Zig Zag Indicator: Filters out small price movements to better identify significant trends and changes in market direction.
  21. TRIX: Shows the rate of change of a triple exponentially smoothed moving average to filter out insignificant price movements.
  22. Detrended Price Oscillator (DPO): Removes the trend effect of price movement to identify cycles and overbought/oversold levels.
  23. Keltner Channels: Consist of volatility-based bands set above and below an exponential moving average.
  24. Volatility Index (VIX): Measures market risk and investors’ sentiments by calculating volatility from S&P 500 index options.
  25. Pivot Points: Are used to determine directional movement and potential support and resistance levels.
  26. Standard Deviation: Quantifies the amount of variation or dispersion of a set of data values.
  27. Average Directional Index (ADX): Measures the strength of a trend and can help determine if a trend is strong or weak.
  28. Envelopes: Consists of two moving averages that define upper and lower price range levels.
  29. Market Facilitation Index: Evaluates the efficiency of price movement by comparing the price changes to volume.
  30. Vortex Indicator: Identifies the start of a new trend or the continuation of an existing trend within market data.
  31. Fractals: Indicates local tops and bottoms where the market reverses.
  32. Gann HiLo Activator: Determines market trends based on past price information to predict future price movements.
  33. Ultimate Oscillator: Combines short, medium, and long-term market trends in a single oscillator.
  34. Chande Momentum Oscillator (CMO): Measures pure momentum based on recent up and down movements.
  35. Dynamic Momentum Index: Adjusts the time period of measurements based on market volatility.
  36. Aroon Indicator: Determines whether a stock is in a trend, the magnitude of the trend, and the probability of its continuation.
  37. Hull Moving Average (HMA): Provides faster and more accurate signals by reducing the lag from traditional moving averages.
  38. Linear Regression Indicator: Indicates the direction of a market trend by fitting a linear regression line through price data.
  39. Coppock Curve: An oscillator that uses rate of change and a weighted moving average to measure momentum.
  40. Fisher Transform: Converts prices into a Gaussian normal distribution to identify price reversals.
  41. Volume Weighted Average Price (VWAP): Gives an average price a security has traded at throughout the day, based on both volume and price.
  42. Heikin Ashi: Uses average price data to create a visually smoother chart, making it easier to identify market trends.
  43. Demark Indicators: Forecast price exhaustion points and potential market turns using time-sequenced points.
  44. Super Trend: Combines price and volatility data to identify the direction of the market trend.
  45. Schaff Trend Cycle: Combines the MACD and Stochastic indicators to generate more overbought and oversold levels.
  46. Price Oscillator: Shows the difference between two moving averages of the price.
  47. Qstick Indicator: Measures the buying and selling pressure of an asset over a specified period.
  48. True Strength Index (TSI): Double-smoothed oscillator that filters out insignificant movements and highlights the trend direction.
  49. Force Index: Combines price movements, volume, and volatility to measure the force behind a price movement.
  50. McGinley Dynamic: Aims to solve the lag issue associated with traditional moving averages by adjusting its speed based on market volatility.

Oscillating indicator strategies

Which is the best oscillating indicator for trading strategies? When you start out in trading it might be a daunting task to understand all the bells and whistles provided by your trading software. There are plenty of indicators, moving averages, and oscillators to use. How can you use the indicators to make money? In this article, we test six different indicators to find a winner.

Here you can find more than 200 trading strategies similar to the above strategies.

FAQ:

Why is Williams %R ranked as the best oscillating indicator for trading strategies?

An oscillating indicator is a type of technical analysis tool that moves within a specific range. Williams %R is ranked the highest due to its stability and consistently low average maximum drawdown, a crucial factor for short-term traders. Despite not having the highest returns, its reliability in minimizing risk makes it a preferred choice.

How do oscillating indicators differ from other types of indicators in trading?

Oscillating indicators, such as Williams %R, RSI, and Stochastics, measure the relative strength or weakness of a security within a specific timeframe. They help traders identify potential reversal points based on overbought or oversold conditions, distinguishing them from trend-following indicators.

What criteria were used to evaluate the best oscillating indicator in the backtests?

The evaluation criteria included factors like profit factor, number of trades, and maximum drawdown. These metrics were considered to determine the stability, profitability, and risk management capabilities of each oscillating indicator in the tested strategies.

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