The Elliott Wave Oscillator (EWO) is the difference between a 5-period and a 35-period simple moving average (SMA) based on the close of each candle.
In terms of formula, it can be expressed as follows:
EWO = SMA (5 period, close candle) – SMA (35 period, close candle)
Uses of Elliott Wave Oscillator
The interpretation of the EWO can be done through what its individual components tell you.
The 5-period moving average is more responsive to price than the 35-period moving average. Fewer price data points are included in the 5 periods. The 35-period moving average is slower to react to price because the previous closing price was only 2.9% of its value (1/35). A 5-period moving average, on the other hand, is based on 20% of the previous candle’s closing price.
Therefore, if the price is in an uptrend and this uptrend has been stronger five candles ago than the previous 35, the EWO will be positive. If the price is in an uptrend, but the price has been in a stronger uptrend than 35 candles ago compared to the previous year, the EWO will be negative.
Likewise, we can apply this to a downtrend. A stronger downtrend in the past five candles compared to the past 35 will create a negative value for EWO. A downtrend over the last five candles that is not as strong as the one in the last 35 candles would also create a negative value for the EWO.
Therefore, we can interpret positive or negative EWO values in different ways:
Positive EWO Value
a) Strengthening the trend OR
b) Weak downtrend
negative EWO value
a) Strengthening of the downtrend OR
b) Weak uptrend
Elliott Wave Oscillator Trading Example
The Elliott Wave Oscillator is basically a trend following indicator.
We can view it in one of two ways. We can look at its value – positive or negative – or we can look at its rate of change.
If EWO is both positive and bullish, this is a bullish sign on two fronts. The short-term trend is bullish and the uptrend is getting stronger.
If the EWO is both negative and rising, this will inevitably decrease. The short term trend is down and the downtrend is getting stronger.
If we require those two conditions to be met at the very least, it has the potential to increase its accuracy. A simple explanation could be to go long when the indicator is positive and short when the indicator is negative. However, trading on signals inherently lagged is not the best idea.
Many factors should line up to help confirm a trade signal. This may include the use of price, support and resistance levels, various technical indicators, and fundamental analysis of the market being traded. Basically whatever it takes to make the right trading decisions.
The EWO itself will generate a ton of signals due to the natural frequency of the 5-SMA and 35-SMA interferences. But it is not a valid trading system in itself, so strict filtering is necessary. Pairing it with a longer period moving average (e.g. 50 or 100 period SMA) and taking a trade in the direction of the trend as indicated by that indicator will improve its reliability.
Also, instead of a positive value just for EWO, we can also improve its reliability even better by ensuring that for long transactions its value is positive enough by a particular magnitude . For short trades, we can create a rule where the EWO is negative by a certain amount. This helps strengthen markets where frequent moves above and below the indicator’s zero line can give a lot of weak signals.
Elliott Wave Oscillator Trade Criteria
So we will look at how the Elliott wave oscillator could have performed on different chart examples using the criteria below:
1) Long trade: Positive EWO value (of + X amount) + Increase in EWO value + 50 period simple moving average
2) Short trade: Negative EWO value (quantity of X) + Decline in EWO value + 50-period sloping simple moving average
Exit strategy:
1) Long exit: EWO strength starts to decline or simple moving average turns negative
2) Short exit: EWO strength rising or moving average creature simply turns positive
In other words, for long-term trading, we want the EWO to be in the process of not only being positive, but increasingly active. The trend, as explained through the simple moving average, should also be positive.
For short-term trading, we want the EWO to be not only negative, but increasingly negative. We also want the simple moving average to be negative.
An exit will be required when any one of the given signs is broken.
Example 1
Take a look at the daily chart of S & P 500.
During this nearly nine-month period, we have nine trades – 7 longs and 2 shorts, as marked between the vertical white lines. They are generated when all three of our criteria are met.
For a long time, this means that the positive EWO value has a certain magnitude, the EWO value increases, and the SMA slopes positively.
For shorts, this means a negative EWO value of a certain magnitude, a decreasing EWO value, and a negative slope of the SMA.
In general, the long seven makes a bit of profit, taking advantage of the continuous uptrend. Two pairs of shorts almost broke even.
Example #2
Below we have a daily chart of EUR/USD.
In this case we have six trades – 3 shorts and 3 longs, again marked between vertical white lines.
Our short criteria are maintained in every short trade – negative EWO, EWO of -0.05 or less (this value will vary by asset and time frame), EWO drop and moving average simple transfer of 50 cycles.
Our long-term criteria – positive EWO, +0.05 EWO or higher, EWO gain, and positive 50-slope simple moving average – are also held throughout.
Each of the first four is a winner to some extent. The last two almost broke even.
Conclusion
The Elliott Wave Oscillator uses the basic concept of a moving average crossover to generate trade signals. It is basically a trend-following momentum indicator.
Trades are designed to be executed in the direction of the index. Specifically, this means long transactions for positive EWO readings and short transactions for negative EWO readings. However, it must be combined with other indicators and ideally other forms of analysis as these indicators are not designed to be used on their own.
Prior data integration metrics are inherently laggy. While they may describe the recent past, they may not necessarily give any insight into what will happen in the future.
It is more common for EWO and other moving average crossover indicators, used to confirm trade ideas generated from price charts. They should not be used as signals. If commercial ideas are signaled by the EWO, they should be strictly filtered by other tools.
We can also use EWO on a variety of charting timeframes, from 1-minute compression to monthly (or higher if such a setting exists on your charting software).