Chande Forecast Oscillator (CFO) – a glimpse into the future

Chande Forecast Oscillator (CFO) is named after its inventor – Tushar Chande. The author introduced the indicator in his 1994 book “The New Technical Trader”. The formula calculates the difference between the sum of recent gains and the sum of recent losses and then divides the result by the sum of all price movement over the same period.

In mathematical terms, it is an extension of linear regression-based indicators. This oscillator plots the difference between the closing price of the stock and the linear regression-based price forecast over a specific period of time.

IQ Option terminal offers the Chande Forecast Oscillator among its standard tools and many traders use it as part of their trading strategy separately or in combination with additional tools. The oscillator is above the zero point if the forecast price is higher than the current price. On the contrary, if it is below it turns out to be less than zero. When the forecast price and the current price are equal, the oscillator makes a zero. Current prices that are constantly over the forecast price suggest higher prices ahead and prices that are constantly under the forecast price suggest lower prices ahead.

Formula and applications of the CFO

The CFO  is similar to Wilder’s Relative Strength Index (Wilder’s RSI) and the Stochastic Oscillator. It measures momentum on both up and down days and does not smooth results, triggering more frequent oversold and overbought penetrations. The indicator oscillates between +100 and -100. Traditionally, it is displayed in a separate window under the trading chart.

The formula calculates the difference between the sum of recent gains and the sum of recent losses and then divides the result by the sum of all price movement over the same period.

The formula may sound complicated but, fortunately, everything is automatic and precalculated. You have to choose the timeframe and the oscillator will be constructed by the algorithm. Experts recommend using a period of 14, regardless of the timeframe. A similar value is set in the IQ Option terminal by default. The chosen time frame greatly affects signals.

How to use the CFO in trading?

Pattern recognition often generates more reliable signals than absolute oscillator levels.

Overbought-oversold indicators are less effective in strongly-trending markets. One of the best strategies is to use CFO as an additional signal. If the oscillator line is above the zero level, and the market continues to fall slowly, then soon there will be a reversal in the bullish direction. And vice versa.

There are some basic rules that every trader should know. The basic rule is that the oscillator is above the zero point if the forecast price is higher than the current price.

  • Prices that are persistently below the forecast price suggest lower prices ahead
  • Prices that are persistently above the forecast price suggest higher prices ahead.
  • The indicator forecasts price trend and trading opportunities.

When the forecast price and the current price are equal, the oscillator makes a zero. Current prices that are constantly over the forecast price suggest higher prices ahead and prices that are constantly under the forecast price suggest lower prices ahead.

There are ways to use the Chande forecast oscillator as the main signal. The oscillator generates a bullish signal when it crosses above the moving average and a bearish signal when it drops below the moving average.

For example:

  • CALL when the oscillator crosses the zero and moving up;

  • PUT when the oscillator crosses the zero and moving down;

The expiration period should be equal to 3-4 bars.

Trading on the CFO alone is risky: so we advise to apply the Martingale principle.

The oscillator can be used as a confirmation signal when it crosses above or below the 0 line.

Traders can use the Chande momentum oscillator to spot positive and negative price divergence between the indicator and underlying security. A negative divergence occurs if the underlying security is trending upward and Chande momentum oscillator is moving downwards. A positive divergence occurs if price is declining but the oscillator is rising.

Chande momentum oscillator computes relative strength visually through patterns that are similar to Wilder’s RSI, with relative positioning between highs and lows determining the longer-term bullish or bearish outlook. Stochastic calculations generate more rhythmic waves, alternating between overbought and oversold extremes. This indicator always utilizes a second “signal” line, in which crossovers higher and lower dictate buying and selling opportunities.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.

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