Williams %R Indicator Overbought and Oversold Trade Signals

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Williams %R Definition and Uses

What is Williams %R?

Williams %R, also known as the Williams Percent Range, is a type of momentum indicator that moves between 0 and -100 and measures overbought and oversold levels. The Williams %R may be used to find entry and exit points in the market. The indicator is very similar to the Stochastic oscillator and is used in the same way. It was developed by Larry Williams and it compares a stock’s closing price to the high-low range over a specific period, typically 14 days or periods.

Key Takeaways

  • Williams %R moves between zero and -100.
  • A reading above -20 is overbought.
  • A reading below -80 is oversold.
  • An overbought or oversold reading doesn’t mean the price will reverse. Overbought simply means the price is near the highs of its recent range, and oversold means the price is in the lower end of its recent range.
  • Can be used to generate trade signals when the price and the indicator move out of overbought or oversold territory.

The Formula for the Williams %R Is:

How to Calculate the Williams %R

The Williams %R is calculated based on price, typically over the last 14 periods.

  1. Record the high and low for each period over 14 periods.
  2. On the 14th period, note the current price, the highest price, and lowest price. It is now possible to fill in all the formula variables for Williams %R.
  3. On the 15th period, note the current price, highest price, and lowest price, but only for the last 14 periods (not the last 15). Compute the new Williams %R value.
  4. As each period ends compute the new Williams %R, only using the last 14 periods of data.

What Does Williams %R Tell You?

The indicator is telling a trader where the current price is relative to the highest high over the last 14 periods (or whatever number of lookback periods is chosen).

When the indicator is between -20 and zero the price is overbought, or near the high of its recent price range. When the indicator is between -80 and -100 the price is oversold, or far from the high of its recent range.

During an uptrend, traders can watch for the indicator to move below -80. When the price starts moving up, and the indicator moves back above -80, it could signal that the uptrend in price is starting again.

The same concept could be used to find short trades in a downtrend. When the indicator is above -20, watch for the price to start falling along with the Williams %R moving back below -20 to signal a potential continuation of the downtrend.

Traders can also watch for momentum failures. During a strong uptrend, the price will often reach -20 or above. If the indicator falls, and then can’t get back above -20 before falling again, that signals that the upward price momentum is in trouble and a bigger price decline could follow.

The same concept applies to a downtrend. Readings of -80 or lower are often reached. When the indicator can no longer reach those low levels before moving higher it could indicate the price is going to head higher.

The Difference Between Williams %R and the Fast Stochastic Oscillator

The Williams %R represents a market’s closing level versus the highest high for the lookback period. Conversely, the Fast Stochastic Oscillator, which moves between 0 and 100, illustrates a market’s close in relation to the lowest low. The Williams %R corrects for this by multiplying by -100. The Williams %R and the Fast Stochastic Oscillator end up being almost the exact same indicator. The only difference between the two is how the indicators are scaled.

Limitations of Using the Williams %R

Overbought and oversold readings on the indicator don’t mean a reversal will occur. Overbought readings actually help confirm an uptrend, since a strong uptrend should regularly see prices that are pushing to or past prior highs (what the indicator is calculating).

The indicator can also be too responsive, meaning it gives many false signals. For example, the indicator may be in oversold territory and starts to move higher, but the price fails to do so. This is because the indicator is only looking at the last 14 periods. As periods go by, the current price relative to the highs and lows in the lookback period changes, even if the price hasn’t really moved.

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Williams %R Indicator: Overbought and Oversold Trade Signals

Williams %R is an indicator similar to the Stochastic Oscillator, but calculated a bit differently. Developed by Larry Williams the indicator reflects the difference between the high, low and the current price over a look back period. Generally that look back period is 14, which could based on any time frame, such as 1-minute, 5-minute, or hourly price bars, etc.

Williams %R

The indicator moves between 0 and -100. A reading between 0 and -20 shows the price is near its high over the look back period. A reading between -80 and -100 shows the price is near its low over the look back period.

Commonly these areas are called “overbought” (0 to -20) or “oversold” (-80 to -100), although these labels can be deceiving. As indicated, all these levels really mean is the current price is trading near the high of the look back or near the low. So just because something is overbought doesn’t mean you necessarily want to sell it, or just because something is oversold that you necessarily want to buy it.

Prices can remain in overbought or oversold territory for a long time, especially during a strong uptrend or downtrend respectively.

Trading Applications

One way to use the indicator is to watch for overbought levels and then a move back below the mid-line (-50). This provides a sell signal.

An oversold level and then a move back above the mid-line (-50) provides a buy signal.

Figure 1. S&P 500 15-Minute Chart with Williams %R Signals (click for full size)

In figure 1 the buy and sell signals are marked with vertical lines–green for buy and red for sell.

During strong moves and the indicator worked better. Since it will always lag behind the price, when the price movements are large, by the time the trader gets the signal there is still room to get in and make a profit.

During quiet conditions there are likely to be more false signals, where a buy or sell signal is given but the price doesn’t follow through in that direction.

Instead of using these as trade signals though, they are likely better used as just an indication that the trend has shifted.

Using price analysis can also help cut down on the number of false signals. If there is a strong uptrend on the chart, then only trade the buy signals. If there is a strong downtrend on the chart, only trade the sell signals (see: When a Trend is Trustworthy and When It Isn’t).

The Williams %R can also be used to gauge momentum. During a downtrend you want to see the price continually reach below -80 to confirm that the downtrend has strength. If the price stops reaching -80 or below, then it signals that the downtrend is losing strength and an upward reversal may be coming.

During an uptrend you want to see the indicator move above -20 on a regular basis. If it can’t do it, it shows the uptrend is losing strength.

Figure 2 shows a few examples of this method.

Figure 2. Determining Momentum with Williams %R (click for full size)

Starting from left to right, we see a strong drop in the price and indicator, and a small rally on the indicator can’t get back to -20, which helps confirm momentum is strong down.

In the middle example, the indicator moves from oversold to overbought (price is in a small range) but when the indictor moves back down it barely gets -80 (higher than prior indicator lows), showing some underlying strength. This warned that the price could pop higher, which it did.

On the right we have a strong uptrend and indicator remains overbought for some time. It then falls below -50 and on the rally back just barely makes it to -20. This high on the indicator was significantly lower than the prior highs, indicating the trend had lost some steam. From there the price drifted lower.

Final Word

While it is possible to use this indicator for trade signals, it’s not recommended. Rather use the indicator for confirming other analysis you are doing and to spot underlying weakness or strength. Adjust the parameters of the indicator, such as giving it a shorter or longer look back period, to align it with your strategies and analysis methods. If you do decide to use the indicator for trade signals, use it during trends and when price is moving strongly. You may also opt to use slightly different levels, or techniques for entering and exiting trades than the standard applications mentioned above.

Indicators for Overbought and Oversold Stocks

Identifying stocks that are overbought or oversold can be an important part of establishing buy and sell points for stocks, exchange-traded funds, options, forex, or commodities. An oversold market is one that has fallen sharply and expected to bounce higher. On the other hand, an overbought market has risen sharply and is possibly ripe for a decline. Though overbought and oversold charting indicators abound, some are more effective than others.

Relative Strength Index

Two of the most common charting indicators of overbought or oversold conditions are relative strength index (RSI) and stochastics. Developed by J. Welles Wilder Jr. and introduced in the 1978 book New Concepts in Technical Trading Systems, RSI is a measurement of stock price change momentum. RSI is a range-bound oscillator, meaning that its value fluctuates between 0 and 100 depending on the underlying security performance, and is calculated based on prior periods’ average gains versus losses.

Key Takeaways

  • Overbought and oversold indicators abound, but RSI and stochastics have stood the test of time.
  • Relative strength index indicates overbought conditions when it moves towards 80 and oversold conditions when it falls below 30.
  • While RSI is computed using average gains and losses, stochastics compares the current price to its range over a given period of time.
  • RSI and stochastics are available on most charting applications, and the default setting is 14 periods, which can be days, weeks, or months.

When RSI indicator approaches 100, it suggests that the average gains increasingly exceed the average losses over the established time frame. The higher the RSI, the stronger and more protracted the bullish trend. A long and aggressive downtrend, on the other hand, results in an RSI that progressively moves toward zero.

RSI levels of 80 or above are considered overbought, as this indicates an especially long run of successively higher prices. An RSI level of 30 or below is considered oversold.

As the number of trading days used in RSI calculation increases, the indicator is considered to be more accurate. Therefore, an RSI computed on a weekly chart is more compelling than one on a daily chart. The standard (default) on most charting applications is 14 periods, which can be measured in minutes, days, weeks, months, or even years.

Stochastics

While relative strength index is calculated based on average gains and losses, stochastics compares the current price level to its range over a given period of time. Stocks tend to close near their highs in an uptrend and near lows in a downtrend. Therefore, price action that moves further from these extremes toward the middle of the range is interpreted as an exhaustion of trend momentum.

A stochastic value of 100 means that prices during the current period closed at the highest price within the established time frame. A stochastic value of 80 or above is considered an indication of an overbought status, with values of 20 or lower indicate oversold status. Like RSI, the default setting for stochastics is 14 periods.

The Bottom Line

Both the relative strength index and stochastics have strengths and weaknesses, and the indicators are best used in combination with other tools designed to establish optimal buy and sell points. Lastly, there are times when a stock, commodity, or market can stay overbought or oversold for a considerable time period before a reversal. Therefore, overbought or oversold signals from RSI or stochastics can sometimes prove premature in strong trending markets.

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