How To Tell When A Commodity Is Oversold

by Larry Williams, excerpt from his book, How I Made One Million Dollars ... Last Year ... Trading Commodities.

Enough about concepts and abstracts. Here, exactly, is how I identify an overbought or oversold market.

My method may, or may not be the ultimate answer to Yin and Yang. However, it is the best I have found considering the irrational character of price action and the ease of constructing the index. As an additional bonus, the index is done on a basis so you know exactly the nature of an extreme. Overbought/oversold indices that use only the price range from one point to another have no absolutes. Thusly, what was oversold at one time period may not be oversold at another. I'll refer to the index as % of R, or %R. The index is a simple measure of where today's closing price fits within the total Range of the last ten days.

Let's say the range for the last ten days was ten points, with the highest high of the last ten days at 65, and the lowest low of the last ten days at 55.

Today's closing price is 58. As you can see from the illustration the close is quite low, within context of the total range during the last ten days.

In terms of percentages, the close at 58 represents a figure that is 70% of the total range.

Should the commodity have closed at 55, the % would be 100%. That is, the close is 100% of the distance from the top of the range to the close. If prices had closed at 65, the % reading would have been 0 because the distance from the close is 0% of the distance from the high to the close.

The exact formula for arriving at %R is first to determine the distance from the highest high of the past ten days and the lowest low of the last ten days. This is the "Range".

Then, take the difference from the high of the last ten days, which you have already identified, and today's closing price. We'll call this "Change".

All that's left to do is divide the Change figure by the Range figure and you will arrive at what % today's price is - out of the last ten day's range. It's as simple as that. Here's an example. Let's say Silver had a high of 280.5 the last ten days and a low of 272.5. Today's close is 278.5. The Range (high to low) is 80. The Change (today's close to 10 day high) is 20. When we divide 20 by 80 we arrive at what % today's closing level represents of the total ten day range. In this case, the %R reading is 25%.

Plot this daily reading on your chart paper. It will, naturally, range from a Yang, (overbought reading at 0%) to Yin, (an oversold reading at 100%). Generally speaking, readings below 95% give a buy indication - during bull markets. A reading above 10% gives a sell signal during bear markets.

The preceeding paragraph is the essence of my technical system. The %R index will not work if you insist on acting on the buy signals during a bear market. Now you realize why I have, in earlier chapters, stressed so strongly, the necessity of isolating the dominant bull and bear markets. Once you've done that, all you have to do is track price movements with %R and wait for the signals telling you it's time to start positioning the commodity according to the fundamental situation we have discussed.

More from Stock & Commodity Futures Trading

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» Trading is a Business
» Average True Range (ATR) - An Indispensable Tool
» Using Average True Range (ATR) in Entry Logic
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» Donchian's 20 Trading Guides
» How to Set Stop Points
» Market Timing
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