The Elliott Wave Oscillator (EWO) is the difference between the 5-period and 35-period simple moving average (SMA) based on the close of each candlestick. In formula, it can be expressed as:
EWO = SMA (5-period, candle-close) – SMA (35-period, candle-close)
Use of Elliott Wave Oscillator
Interpretation of EWO can be done through what its components tell you.
A 5-month moving average is more responsive to price than a 35-year moving average. The lower price data points include a 5-year period. The 35-week moving average is slower to react to price because the previous closing price is only 2.9% of its value (1/35). A 5-period moving average, on the other hand, is based on 20% of the closing price of the previous candle.
Therefore, if the price is in an uptrend, and this uptrend is stronger over the previous five candles than over the previous 35, then the EWO will be positive. If the price is in an uptrend, but the price has risen on a total of eight 35 candles compared to the previous five, the EWO will be negative.
Likewise, we can apply this to a downtrend. A stronger downtrend over the past five candles than over the past 35 would produce a negative value for EWO. A bearish trend over the recent five candles that is not comparable to the past 35 candles will also produce a negative value for the EWO.
Therefore, we can interpret positive or negative EWO values in different ways:
Positive EWO values
- a) Strengthening the OR trend
- b) Reduce the downward flow
Negative EWO values
- a) Strengthening the downtrend OR
- b) Increase the upward flow
Trading Example from the Elliott Wave Oscillator
The Elliott Wave Oscillator is basically a trend indicator.
We can look at it in one of two ways. We can see the value – positive or negative – or we can see the rate of change.
If EWO is positive and increasing, this is a sign of rising prices in two areas. The short-term trend is up and the uptrend is getting stronger.
If EWO is both negative and rising, this is a double bearish. The short-term trend is bearish and the downtrend is getting stronger.
If we need both of those conditions to be met when trading at least, it will increase the accuracy. A simple interpretation might be long when the indicator is positive and short when the indicator is negative. However, trading based on signals that the price lags again is not the best idea.
Many factors should line up to help validate a trading signal. This can include the use of prices, support and resistance levels, different technical indicators, and fundamental analysis of the market being traded. Basically what it takes to get the trading results right.
The EWO itself will produce a ton of signals due to the natural frequency of the 5-SMA and 35-SMA crossovers. But by itself it is not a legitimate trading system, so strict censorship is required. Pairing it with a longer moving average (eg 50- or 100-period SMA) and taking trades in the direction of the trend as determined by the indicator will increase its reliability.
In addition, not only the positive value for EWO, we can also increase its reliability by ensuring that for long trades, the value is positive enough with a certain magnitude. For short trades, we can create a rule where the EWO is negative by a certain amount. This helps in consolidating markets where frequent moves above and below the indicator’s zero line can give multiple weak signals.
Elliott Wave Oscillator Trading Criteria
Therefore, we will see how the Elliott Wave oscillator might stand out on various chart examples using the criteria below:
1) Old trade: Positive EWO value (sum + X) + Increasing EWO value + Positive 50-slop medium moving average
2) Short Trade: Negative EWO value (total -X) + Decrease in EWO value + Negative 50-slop medium moving average
Exit strategy:
1) Long exit: the magnitude of the EWO starts to decrease or the medium moving average turns negative
2) Short exit: EWO magnitude creatures increase or medium moving average turns positive
In other words, to trade long, we want EWO to be in the process of becoming not only positive, but increasingly positive. The trend, as translated through a simple moving average, should also be positive.
To trade short, we want the EWO to not only be negative, but increasingly negative. We also want the simple moving average to be negative.
Exit will involve when one of the given signs is broken.
Example #1
Let’s take a look at the daily chart of the S&P 500.
Over this nine month time period, we have nine trades – 7 longs and 2 shorts, as marked between the vertical white lines. This is generated when all three of our criteria are met.
For the long term, this means a positive EWO value of a certain magnitude, an increasing EWO value, and a positive SMA.
For shorts, this means a negative EWO value of a certain magnitude, a declining EWO value, and a negative SMA.
Collectively, the seven misses produced modest gains, taking advantage of the ongoing uptrend. Two shorts about to break though.
Example #2
Below we have the daily chart of EUR/USD.
In this case we have six trades – 3 shorts and 3 beds, again marked between the vertical white lines.
Our short criteria are held throughout each short trade – negative EWO, EWO of -0.05 or lower (this value will vary by asset and time frame), decreasing EWO, and negative negative 50-step moving average.
Our long criteria – positive EWO, EWO +0.05 or higher, increasing EWO, and a positive 50-average moving average – are also held throughout.
Each of the first four is a winner to some extent. The last two are about to break.
The conclusion
The Elliott Wave Oscillator uses the basic concept of a moving average crossover to generate trading signals. It is basically a trend-following, momentum indicator.
Trades are designed to be taken in the direction of an indicator. That is, it means a long trade for a positive EWO reading and a short trade for a negative EWO reading. It must be paired with other indicators and ideally other forms of analysis as these indicators are not designed to be used on their own.
Indicators that integrate previous data are simply price lags. Although they may describe the past, they may not necessarily deny what will happen in the future.
It is more common for EWO, and other moving average crossover indicators, to be used to confirm trade ideas generated from price charts. It is not recommended to use them as signals themselves. If the trading ideas are characterized by EWO, they should be strictly filtered by other tools.
We can also use EWO on various chart timeframes, from 1-minute compression times up to monthly (or higher if that setting exists in your charting software).
