the wave oscillator


DISCLAIMER

This information is exclusively for educational purposes and doesn't constitute an investment advice. What you do with this information is at your own risk and responsibility.

Please read our GENERAL DISCLAIMER before using the information below.

WARNING


We warn everybody from patenting/registering this indicator or any algorithm based upon it or part of it. You will be prosecuted.


FOREWORD


The following article is about the WAVE OSCILLATOR, an indicator created by Mario D. Conti in 2008.

I offer this oscillator for free to the trading community as we think that it's very valuable and it should be shared, as many other authors did in the past (Bill Williams, George Lane and others) with other indicators.





THE WAVE OSCILLATOR



Why the Wave Oscillator?  I created this indicator for a number of reasons. Basically, there was the need of an oscillator:

  • to "visually" display Entry/Exit points.
  • to "keep you out" if the trading conditions were not ideal to enter a trade.
  • able to display an initial stop and a trailing stop 
  • to be used without charting knowledge or technical analysis expertise.

What didn't convince me about the other indicators:

  • they are based mostly upon a close/open price which:
    - it's determined quite "artificially" for stock indices
    - it's totally artificial with infra-day charts
    - it's absolutely artificial when applied to currencies
  • they are based upon a comparison of present and past volatility which, too often, it doesn't make any sense.
  • they are cumbersome to use and too open to a personal interpretation.





BACKTESTING:



This oscillator has been manually tested and backtested on real trades since 2012. Both tests seem to be very promising.


However, third party tests are still welcome. Hence: 
I invite the trading community to further test this oscillator and share the results with me.

Please contact Mario D. Conti at info[(aatt)]fxtutors.com.au.






WHAT THE WAVE OSCILLATOR IS BUILT UPON:


The Wave Oscillator (WO from now on) is a trading band made of four displaced moving averages. More exactly, they are four 7-periods Exponential Moving Averages (EMA) based on HIGHS and LOWS:

  • 2 displaced EMAs based on highs
  • 2 displaced EMAs based on lows.

Each EMA is displaced forward or backward for a number of periods.



HERE'S HOW IT LOOKS




click to enlarge




The chart in the background was intentionally set with gradient colours to enhance the Wave Oscillator from the underlying graph




PREMISES



The Wave Oscillator  was conceived to:

  • catch the longest trends only
  • catch high volatility trends only
  • keep the ATS (Automated Trading Systems) or the trader out of non-trending markets


To do that, we use a set of

  • 3 separate entry signals
  • based on 3 different time frames:
- 1-hour chart
- 4-hour chart
- daily chart




GENERAL RULE FOR ENTERING A TRADE




The entry system described below is a “cascade procedure and it was designed specifically for Automate Trading Systems (ATS).

Manual traders should skip the “FIRST ENTRY SIGNAL” as it requires a split second reaction time and a very fast execution.

For manual traders the “MIDDLE ENTRY SIGNAL” is recommended.




FIRST ENTRY SIGNAL



The trade is originally entered by the Wave Oscillator  build upon the 1-hour chart which provides:
  •  the first ENTRY SIGNAL and
  • the first TRAILING STOP




MIDDLE ENTRY SIGNAL


If, after sometimes in the trend, we also have an entry signal from the Wave Oscillator built upon the 4-hour chart (middle entry signal), this new entry signal will supersede the one from the 1-hour chart and take over the ongoing trade.

Hence, the initial trailing stop will be replaced by the new trailing stop provided by the 4-hour chart (middle trailing stop).

If no middle entry signal occurs, there will be no take over



TOP ENTRY SIGNAL



If, after sometimes in the trend, we have an entry signal from the Wave Oscillator  built upon the daily chart (top entry signal), this new entry signal will supersede the one from the 4-hour chart and take over the ongoing trade.

The middle trailing stop will be replaced by the new trailing stop provided by the daily chart (top trailing stop).

If no top entry signal occurs, there will be no take over




NOTE

After the daily WO takes over, the trailing stop built upon the daily chart is the one supposed to EXIT the trade.

However, the Wave Oscillator  provides also a signal that triggers an earlier exit. See further ahead.





SETTING THE WAVE OSCILLATOR



FIRST SET OF M.A. 

  • M.A. 1: 7-periods E.M.A., shift: +2, apply to: LOW, colour: red
  • M.A. 2: 7-periods E.M.A., shift: -2, apply to: HIGH, colour: magenta

SECOND SET OF M.A. 

  • M.A. 3: 7-periods E.M.A., shift: -2, apply to: LOW, colour: black
  • M.A. 4: 7-periods E.M.A., shift: +2, apply to: HIGH, colour: blue







ENTRY SIGNALS





GENERAL PRINCIPLES


The ENTRY SIGNAL is given exclusively whenever a pair of EMAs with similar colour moves inside the trading band.

Line pairs with similar colour:


  • The red line and the magenta line have similar colours, forming the red-magenta pair.
  • The blue line and the black line have similar colours, forming the blue-black pair.

On the other hand, whenever an EMA pair moves outside the trading band it’s no longer useful to our purposes.

Hence, our attention always focuses to the EMA pair inside the trading band.








ENTRY SIGNALS




CROSSOUTS: 2 types of entries

Below two types of entries, according to the line cross outs

  • Inside cross out
  • Outside cross out + divergence




DIVERGENCE - Principles behind a divergence


It’s important to stress out that the Wave Oscillator was built to catch major turning points (MTP). These MTPs typically occur at the end of a 5-waves-uptrend or at the end of a 3-5 waves-retracement.

Trends arising from accumulation areas don’t usually lead to MTPs as they are continuation patterns from previous trends.

Instead, at the very end of an important trend, just before a new major turning point, few things usually occur:
  • The volatility increases
  • We have longer red candles
  • We have a reversal candlestick

  



ENTRY SIGNAL - UPTREND






INSIDE CROSS OUT

In an uptrend, the entry signal is given by the cross out of the blue-black pair (the blue line crosses the black line) inside the trading band.

Note: the blue-black pair must move inside the trading band whilst the red-magenta pair moves outside the trading band.






OUTSIDE CROSS OUT + DIVERGENCE

In an uptrend the entry signal is given by the cross out of any of the blue-black lines with any of the red-magenta lines.

A valid signal must comply with four conditions:
  • Both blue-black lines must cross the red-magenta lines from outside the trading band and move inside the trading band.
  • The cross out must occur with an angle of intersection of 60-90 degrees.
  • Both blue-black lines must cross the red-magenta lines (a single cross is not a valid signal).
  • The outside cross out must be preceded by a wide divergence of the re-magenta pair.




DIVERGENCE

At the very end of a downtrend a sudden wide divergence of the red-magenta lines appears and the major downtrend - still on course - will soon come to an abrupt end.

Basically, the red and magenta lines suddenly point towards the outer boundaries of the trading band.

This divergence precedes the outside cross out and it’s used a prerequisite/confirmation of the imminent outside cross out.




click to enlarge






ENTRY SIGNAL - DOWNTREND






INSIDE CROSSOUT

In a downtrend, the entry signal is given by the cross out of the red-magenta pair (the magenta line crosses the red line) inside the trading band whilst the blue-black pair moves outside the trading band.

Note: the red-magenta pair must move inside the trading band and the blue-black pair must move outside the trading band.





OUTSIDE CROSSOUT

In a downtrend the entry signal is given by the cross out of any of the red-magenta lines with any of the blue-black lines.

A valid signal must comply with four conditions:
  • Both red-magenta lines must cross the blue-black lines from outside the trading band and move inside the trading band.
  • The cross out must occur with an angle of intersection of 60-90 degrees.
  • Both red-magenta lines must cross the blue-black lines (a single cross is not a valid signal).
  • The outside cross out must be preceded by a wide divergence of the blue-black pair.




click to enlarge







EXIT SIGNAL



The exit signal - for both uptrends and downtrends - is triggered by the trailing stop. A trailing stop must be set as soon as we have an inside cross out.

However, this cannot be set unless we have an inside cross out. Hence, an “initial stop loss” must be set after placing the trade and subsequently cancelled as soon as we have an inside cross out.



NOTE 1: The Wave Oscillator provides a clear indication of the “initial stop loss”. See further ahead for “Stop Loss”.

NOTE 2: An EARLY EXIT SIGNAL is provided by the Wave Oscillator. See below: Early Exit signal – uptrend and downtrend.




HOW TO CALCULATE A TRAILING STOP




UPTREND
In an uptrend, the trailing stop is the difference between the cross out of the inside lines and the lowest low. See the image below.




click to enlarge






DOWNTREND


In a downtrend, the trailing stop is the difference between the cross out of the inside lines and the highest high. See the image below.




click to enlarge







TRAILING STOP TRIGGERING THE EXIT



UPTREND: See the image below of a triggered trailing stop in an uptrend




click to enlarge






DOWNTREND: See the image below of a triggered trailing stop in an downtrend.




click to enlarge







EARLY EXIT



The Wave Oscillator also provides an early exit signal to be used according to the specs of the trading strategy (i.e. shorter term strategy).

An early exit signal is triggered by the cross of any line inside the trading band with any line outside.

NOTE: a double cross out is not required for a valid exit signal, nor is recommended.





EARLY EXIT - UPTREND




In an uptrend the inner blue-black pair moves suddenly outside. An exit signal is triggered by the cross of any line of the blue-black pair with any line of the red-magenta pair.



NOTE: a double cross out is not required for a valid exit signal, nor is recommended. See image below.




click to enlarge








 EARLY EXIT - DOWNTREND



In a downtrend an exit signal is triggered by the cross of any line of the red-magenta pair with any line of the blue-black pair. A double cross out is not required. See image below.




click to enlarge







INITIAL STOP LOSS




The outside cross out typically occurs two periods earlier than the inside cross out.

If you enter the trade with an outside cross out you cannot determine the trailing stop as you don’t have one of the two parameters you need: the price at which the inside cross out occurs.

Hence, you need a temporary stop loss: the initial stop loss. let's how it's calculated.




INITIAL STOP LOSS - UPTREND


In an uptrend the initial stop loss is calculated by doubling the distance between the lower low and the lower cross out. NOTE: this very same distance from the lower low can also be used to set up the trailing stop.


I fact, there's usually very little difference (in terms of pips or points) between the trailing stop calculated as previously illustrated and this initial stop loss. See picture below.




click to enlarge





INITIAL STOP LOSS - DOWNTREND


In an downtrend the initial stop loss is calculated by doubling the distance between the higher high and the higher cross out. NOTE: this very same distance from the higher high can also be used to set up the trailing stop.


I fact, there's usually very little difference (in terms of pips or points) between the trailing stop calculated as previously illustrated and this initial stop loss. See picture below.





click to enlarge