It's always useful to have some insight into the strength or weakness of a market. A common type of tool employed by technical analysts for this purpose is an oscillator that indicates whether a market has become overbought or oversold.
This article is going to discuss the Williams Percent Range indicator (also known as the WPR indicator, or Williams %R). It is one of the more popular oscillators used to determine whether a market stands in the overbought or oversold territory. The indicator is named after its inventor, commodity trader and author Larry Williams. Williams has invented many technical indicators, but the %R is probably his best known technical tool.
Many oscillators swing between 0 and 100, but the Williams Percent Range oscillator always stands between the values of -100% and 0%. Of this range, -100% represents the extreme oversold end and 0%, the extreme end of the overbought region.
Let's first talk about how these Williams Percent Range values are calculated and then move on to discussing how to actually use the indicator to trade.
We calculate the Williams Percent Range using the following formula:
Williams % R = (Nth High - Close)/(Nth High - Nth Low) x -100
Where the Nth High is the highest high for the preceding N periods, and Nth Low is the lowest low for the preceding N periods. The close used is the close for the current period.
Basically, this formula is constructed in order to quantify how close the market stands to the outer bounds of a recent range. A value of -100% means the current close is the lowest low for the last N periods. A value of 0% means the current close is the highest high for the last N periods. Values in between show you proportionally where the market stands between these two possible extremes.
MetaTrader 4 comes bundled with a solid selection of indicators, including a large number of oscillators. Among these is the Williams %R. As you can see from the image below, it is the last-listed indicator in the Oscillators folder in MT4's Navigator.
The key parameter that you can alter when launching the indicator is the number of periods, N. As you can see from the image above, the default value in MT4 is 14. Williams himself originally proposed a value of 10 (as is common, the indicator was also originally devised to be used with end-of-day data).
The image below shows the %R added to an hourly AUD/USD chart, using the default period of 14:
You can see the %R indicator labelled beneath the main price chart, and how the turquoise line oscillates between -100% and 0%. Dotted lines on the chart demarcate the -20% and -80% levels. These represent the levels that Williams considered as being overbought and oversold, respectively.
Looking at this example, the %R does a pretty good job, for the most part, of signposting reversals. Those times when the indicator moves into the overbought or oversold regions tends to correspond to changes in the direction of the market. Note though that on the far right of the chart, we see a stretch where we are stuck in the oversold territory without yet seeing a rebound in the price.
The labels overbought and oversold market can be a little deceptive — they cannot be used in isolation to predict a reversal. One way of thinking is that overbought actually represents buying pressure. In the same vein, oversold indications will appear whenever there is selling pressure. The tricky part is that we don't know how long market participants may sustain these pressures. We know at some point there will be a reversal, but we don't know when. In other words, the indicator moving into the overbought or oversold territory tells us nothing about timing in itself.
Remember, the %R will indicate overbought if we are close to the highest high of the recent range and indicate oversold if we are close to the lowest low. Now, if a market is trending upward, we are by necessity breaking new highs. Similarly, in a downtrend, we will be seeing new lows. At such times, the %R will be telling us the market is overbought in the uptrend and oversold in the downtrend. To sell into the uptrend and buy into the downtrend could prove to be costly mistakes. So the smart way to use the indicator is to avoid using it in a trending market.
Such a strategy would only act on overbought or oversold indications when the market is range-bound or moving sideways. To do this, we need to be able to correctly analyse the state of the market. One way to do this is by simply observing price action — looking for the tell-tale higher highs and higher lows that suggest an uptrend (or the lower lows and lower highs that suggest a downtrend).
We could also seek to improve the indicator's usage by waiting for some sign that the directional pressure is easing. So, for example, let's say we see the %R indicator move above 80. We know we are in the overbought territory, and we are now alert to the possibility of a reversal. We don't know how long the buying pressure that has brought us here will last, so we wait. We hold off trading so long as the oscillator stays above 80. As soon as we see the indicator dip out of the oversold region, we initiate a short position in the market.
Most sensible of all is to try and utilise another indicator in conjunction with the Williams Percent Range. As a general rule, it's always worth comparing what one indicator is saying with another, so as to see a bigger picture than just the one indicator in isolation. For example, using the Volumes Indicator can help you look at more than just price ranges as well as help you gain a better feel for what is going on in the market.
The aim is to weed out false signals and act on only those signals in which we have the highest confidence. If your combination of indicators has signals that disagree, it's probably sensible to sit out that trade.
MT4 comes with a number of bundled indicators, as we have seen, but to have a more expansive selection at your disposal, why not download MetaTrader 4 Supreme Edition? MT4SE is a plug-in that vastly extends the functionality of the platform, created by industry professionals to offer a cutting-edge trading experience.
Whatever trading strategy you choose, you are best off putting it into practice first with a Demo Trading Account. No trading strategy works all the time, so you really need to get a feel for the ups and downs in a risk-free environment. This way, you gain the confidence that will bolster your trading discipline when it comes to the real thing. Demo trading also allows you to tweak settings, such the period value N of the WPR indicator, in a safe environment. Trying to determine which value is optimal for your trading style without using real money is a stress-free way to experiment.
The Williams Percent Range is quite a simple tool that compares the current market level to the ranges over a look-back period. By doing so, it gives indications of whether the market is overbought or oversold. General wisdom holds that range-bound markets are the optimal condition for overbought/oversold oscillators. Therefore, you should be very wary of trying to use the %R indicator in a trending market.
If you enjoyed this discussion of the Williams Percent Range, you might also like our article on another oscillator – the Relative Vigor Index Indicator