Topics Indicators

How to Use Williams %R to Identify if a Crypto is Overbought or Oversold

Intermediate
Indicators
Investing
Trading
22 de oct de 2021

It has been said that fundamental analysis will tell you the story, while technical analysis is what signals when to get into and out of a trade. Technical analysis will help you see the direction of the current trend, and when the market is overbought and oversold. The Williams %R is a tool that helps traders identify trend direction, and signals when to buy and sell. In this article, we’ll learn about this relatively unknown indicator, as well as four strategies to trade with it.

What Is the Williams %R Indicator?

Williams %R is a momentum indicator used in technical analysis that measures whether a crypto asset is overbought and due for a correction, or oversold and about to begin a new rally.

Williams %R, also referred to as %R or Williams Percent Range, was developed by Larry Williams and first introduced in his 1979 book, “How I Made One Million Dollars 
 Last Year 
 Trading Commodities. In 1973, the United States formally removed itself from the gold standard and inflation was high and rising. As a result, many commodities experienced strong trends, similar to the cryptocurrency trends we’re witnessing today.

When a market experiences strong trends, you want to utilize momentum indicators and tools to help you identify trading opportunities. Williams %R is a momentum indicator that generates easy-to-follow trading signals which allow traders to time their entries and exits.

Williams %R Formula

The %R formula uses this calculation:

In essence, the calculation determines how close the current price is to a recent high or low. For example, a reading of −10 suggests the asset is within the top 10% of the range. On the other hand, a reading of −90 suggests the asset is within the bottom 10% of the range.

The %R is a bounded oscillator. This means (in this case) that the output values cannot be greater than zero or less than −100. Bounded oscillators are excellent tools for providing traders signals of overbought or oversold assets, as the signals are easy to read.

With Williams %R, a reading above −20 is considered to be overbought. If a cryptocurrency goes above −20, then it’s approaching its recent highs and may be due for a correction.

On the other hand, a reading below −80 is considered oversold, suggesting a bullish reversal may occur soon because the market has sold off hard.

Pros and Cons of Williams %R

Like other technical indicators, the Williams %R has both advantages and limitations.

First, as a bounded oscillator, Williams %R makes reading overbought and oversold signals fairly simple: −20 represents overbought and −80 represents oversold. No additional math calculations are needed to interpret when a crypto asset has become overbought or oversold.

The biggest limitation to a bounded oscillator is that markets can remain overbought or oversold for extended periods of time. For example, if the Williams %R is vacillating between −.05 and 0, it simply means that the market is hovering near its high for the defined lookback period.  

To put it another way, if the market is in a strong uptrend, it could experience %R readings in overbought territory for an extended period of time, with the opposite being the case for downtrends.

Another limitation to the Williams %R is the scale it uses. I believe %R was created with uptrends in mind and, therefore, intended for use in determining how close to the range high the market is. Thus, the market will always be a percentage off from the high, which is why Larry Williams multiplies the ratio by −100.

However, the scale is counterintuitive when you’re reading it. As humans, we easily understand uptrends and positive numbers. Negative numbers take more mental capital for us to comprehend. Therefore, with nearly all readings of the Williams %R in negative territory, it requires more energy for us to interpret the numbers.

How to Trade Using Williams %R

Williams %R is a versatile oscillator, and yields many uses. It has a variety of patterns which provide fruitful buy and sell signals. Below, we’ll share four strategies that a crypto trader can use with the Williams %R indicator.

Buying Oversold and Selling Overbought

One of the advantages of the Williams %R is its clearly defined overbought and oversold levels.

When an asset is oversold and below −80, a trader can buy once the market crosses back up above −80. In overbought conditions, a crypto trader can wait to sell until the crypto market crosses below −20. The chart above is illustrated with green vertical lines representing buy signals, and red vertical lines representing sell signals.

We can add another layer to this simple strategy by filtering trades solely in the direction of a trend. The goal of this refined strategy is to only take advantage of signals that align with the larger trend’s direction, while ignoring counter-trend signals.

Above, we’ve removed the short signals, filtering only for buy signals as the Bitcoin trend is up. Notice that when Williams %R drops below −80 into the oversold region, a rally follows soon thereafter.

To sum up this strategy, a trader would buy in an uptrend when the %R crosses above −80, while ignoring all short signals. In a downtrend, the trader would short when %R crosses below −20, while ignoring all long signals.

Midline as a Trend Filter

Another way to use the %R is to focus on the midline at −50. 

Above, we’ve marked the middle of the oscillator with a dotted line at −50. When the Williams %R moves above this midline, it signals that the trend is up and may continue to move higher.

On the contrary, when the %R line is below the −50 midline, it suggests a weak market that may weaken further.

Obviously, the %R line will cross back and forth between bullish and bearish territory. But generally speaking, it stays contained within one zone for a while. Therefore, a trader could look to initiate positions when the indicator’s line crosses −50 in either direction.

Bullish and Bearish Oscillator Divergence

There are times when the oscillator will move independently of price action, creating divergence. When you spot this happening, it signals that a trend change may soon appear.

For example, on the 2-hour Bitcoin chart above, the price is trading higher from September 13–21. After a brief correction beginning September 21, Bitcoin rallies again to reach a new high.  

However, the %R oscillator does not rally to a new high. This divergence, with the oscillator not confirming the new high in price, is a bearish signal that suggests a correction may be at hand. In fact, within a few hours, Bitcoin fell 20%.

The opposite can also occur with bullish divergence.

This 4-hour Bitcoin chart from April 2021 illustrates an instance of bullish divergence. Bitcoin’s price falls going into the first low on April 23. The Williams %R oscillator is deeply oversold, and Bitcoin rallies a small amount.

Then, Bitcoin corrects lower again to reach a new low. However, the %R oscillator doesn’t  — which creates bullish divergence. Bitcoin goes on to rally 30% over the next several days.

Williams %R Failure Swing Strategy

There are times when the market is so strong that corrections are very shallow, tending not to become oversold. It’s during these strong markets that you want to be positioned well. The failure swing strategy can help.

On the Bitcoin daily chart above, you can spot when the Williams %R line is trying to correct lower. However, the market is so strong that the %R line barely drops below −50, and doesn’t reach the −80 oversold region.

This is a bullish failure swing because the swing low doesn’t reach oversold levels. If you spot situations like these on a chart, look for opportunities to position yourself to the long side.

With the benefit of hindsight, we can now see that Bitcoin rallied nearly 3× over the next four months as a result of this bullish energy.

Williams %R vs. Alternative Trading Indicators

As a bounded oscillator, there are some similarities between the Williams %R and other oscillators. It’s important to understand the similarities and differences between these oscillators so you can determine which one will work best for you.

Williams %R vs. Fast Stochastic Oscillator

The Williams %R calculates the market’s current level relative to the highest high for the lookback period. On the other hand, the fast stochastic oscillator, which moves between 0 and 100, compares the market’s current level to the lowest low. As a result, these two oscillators essentially do the same thing, and appear very similar on charts.

When you inspect these two formulas, you’ll see they look very similar — with two main differences. The first difference, which we’ve already discussed, is that %R compares using recent highs, while fast stochastic compares using recent lows.

The second main difference is the multiplier. Due to this discrepancy, the %R has a limited output range of 0 to −100, while the fast stochastic oscillator has a range of 0 to +100.

Williams %R vs. Relative Strength Index

Another bounded oscillator is the Relative Strength Index (RSI) indicator. Similar to fast stochastic, the RSI indicator also measures between 0 and 100. However, the similarities end there.

The RSI calculation involves averaging the “up” days against the “down” days. In essence, it’s figuring out the strength with which the crypto market rallies on its bullish days vs. its weak  corrections on bearish days. RSI is used to calculate how much a market moves on average.

Notice the difference with the %R, which is a pure price comparison against a range high or low. The Williams %R is calculating how close the current price is to the range high and low.

As a result, you’ll tend to receive completely different values when comparing the RSI to the Williams %R.

Within the Williams %R in the example above, oversold readings below −80 are easy to come by. However, the corresponding RSI readings never do reach the oversold level of 30. As Bitcoin is in an uptrend at the time, its relative strength is apparent in the RSI oscillator, with correspondingly high readings.

The Bottom Line

The Williams %R tool is excellent for helping traders clearly identify overbought and oversold levels for cryptocurrencies. %R is also versatile, as there are four different strategies a trader can deploy when using the oscillator, from simple “buy the dips” to swing failures.

Though the %R scaling isn’t the most intuitive, traders who have worked with stochastic or RSI oscillators will be familiar with how to use Williams %R as an indicator of overbought and oversold markets.