Elliott Wave Oscillator

Ralph Nelson Elliott first described wave theory in 1938 and it’s stood the test of time. The Elliott Wave Oscillator puts it to real use in trading.

  1. What you can do with the Elliott Wave Oscillator

  2. Trading Examples with the Elliott Wave Oscillator

  3. Conclusion

 

The Elliott Wave Oscillator (EWO) is what you get when you take a 35-period simple moving average (SMA) away from a 5-period based on the close of each candlestick.

As a formula it looks like this:

EWO = SMA (5-period, candle-close) – SMA (35-period, candle-close)

What you can do with the Elliott Wave Oscillator

You can understand what the Elliott Wave Oscillator is telling you by considering the outputs of its discrete components.

A 5-period moving average will respond to price much better than a 35-period moving average can manage because it doesn’t have as many price data points. The 35-period moving average doesn’t react as quickly to price because the prior closing price only amounts to around 2.9% of its total value (about one thirty-fifth) In contrast, the 5-period moving average is based on one-fifth of the previous candle’s closing price, giving it much greater scope for assessment.

This means that if the price is experiencing an uptrend that was showing greater strength over the preceding five candles rather than the 35 prior, then the Elliott Wave Oscillator will show a plus reading. If it’s up-trending but it’s had a more potent overall uptrend for the duration of that 35 candle stretch in relation to the last five, the EWO will be in the minus camp.

We can apply the same sort of approach to downtrends too. More potent downtrends for the duration of the preceding five candles as they relate to the past 35 will return a minus amount for the EWO. A downtrend over the last five candles that hasn’t shown as much fortitude as the one over the preceding 35 candles will also return a minus EWO amount.

This means that we can make interpretations either for or against the EWO values in different ways:

Positive EWO value

  1. a) More potent trend OR

  2. b) Less potent downtrend

Negative EWO value

  1. a) More potent downtrend OR

  2. b) Less potent uptrend

Trading Examples with the Elliott Wave Oscillator

At its root, the Elliot Wave Oscillator is fundamentally a trend-following indicator and there are two ways that we can look at it, with the plus and minus values it returns or rate of change serving as indicators.

When the EWO is positive and also on the rise, this is a double-fronted sign of bullishness. The near-term trend is bullish and the uptrend is gaining strength.

If the EWO is both negative and going up, this is doubly bearish. The near-term trend is bearish and the downtrend is increasing in strength.

If we stipulate that those two conditions need to be met as a minimum before embarking on a trade, this should prove to be more accurate. The simple view of this scenario might be that going long is prudent when the indicator is positive and going short is best when it’s showing a minus. But the only problem with that is, it isn’t sensible to base trades on signals that lag price. You’re better off with requiring a multitude of factors to converge in order to assist in the confirmation of your apparent trade signals. To do this you could throw in price, support and resistance levels, various technical analysis indicators, and fundamental market analysis too. Whatever suits. The more quantitative factors the merrier.

By itself, the Elliott Wave Oscillator will give you loads of signals to chew over because crossovers happen as a matter of course with 5-SMA and 35-SMA, but you have to filter them religiously to get anything useful out of the nfo maelstrom. You can pair it with a longer moving average like 50- or 100-period SMA and take trades that run the same way as the trend and the indicator for more dependable results.

On top of that, instead of relying on just any plus value for the EWO, we can make it more reliable for long and short trades by setting specific plus and minus thresholds. In consolidating markets this helps where frequent shifts in either direction beyond the indicator’s zero line could generate the unhelpful clutter of multifarious weak signals. 

Elliott Wave Oscillator Trading Criteria

Let’s examine how well the Elliott Wave oscillator might have fared using some chart examples and the following criteria below:

1) Long trade: Positive EWO value (of +X amount) + escalating EWO value + positively sloped 50-period simple moving average

2) Short trade: Negative EWO value (of –X amount) + decreasing EWO value + negatively sloped 50-period simple moving average

Exit strategy:

1) Exit long: EWO magnitude begins going down or simple moving average turns negative

2) Exit short: EWO magnitude starts going up or simple moving average becomes positive

In a nutshell, to trade long, it helps us if the EWO is not just actively on the plus side but it’s a plus that’s increasing. The trend, as implied by the simple moving average, also needs to be positive.

To trade short, the EWO shouldn’t just be a minus, it should be an increasing minus, and we want the simple moving average to be a minus too.

The time to exit would be when any one of these signals is tripped.

 

Conclusion

The Elliott Wave Oscillator generates trade signals using the basic concept of a moving average crossover. Fundamentally, it’s a trend-following, momentum indicator.

Trades are put together so that they run in the direction of the indicator, which means EWO readings in the plus range elicit long trades and negative EWO readings elicit short trades. Useful as it is though, you can’t rely on this indicator alone to guide your trades, so always include other forms of analysis to round out the intelligence used in your trades.

Any indicator that integrates previous data lags price by default. They might be good at assessing recent price history, but that doesn’t automatically mean that they can shed any light on upcoming events.

More typically, the EWO and other moving average crossover indicators are used for confirmation of trade ideas produced from the price chart. That said, they are useful, and we can employ the EWO across numerous charting timeframes, from 1-minute to monthly, or whatever upper limit your software has in place.