Window Oscillators and Overlay Indicators
It should be noted that many practitioners require that buy and sell reversal
signals based on window oscillators require price confirmation, that is, price is
required to breach an overlay indicator. Just because an indicator issues a bearish
or bullish reversal signal does not necessarily mean that prices have reversed or
broken through a barrier. The signals may be based on oscillator action, but the
trigger for entry or exit must always be based on price action. Oscillator values
breaching overlays do not represent price confirmation but are regarded as merely
a signal of potential bullishness or bearishness.
For a valid price confirmation, price may breach any of the following overlays:■ (^) Numerically based overlays
■ (^) Horizontally based overlays
■ (^) Geometrically based overlays
Nevertheless, the most reliable and popular overlays used for price confirma-
tion are prior support and resistance levels, simple trendlines, moving averages,
and chart pattern breakouts or reactions.
ObOs Overextended Levels
Overbought and oversold (OBOS) levels are indicative of overextensions in price,
where a potential reversal in price is expected. It should be noted that an over-
bought signal is first and foremost an indication of a strong uptrend in effect, with
a high probability of a potential bearish reversal. Similarly, an oversold signal
is first and foremost an indication of a strong downtrend in effect, with a high
probability of a potential bullish reversal. As such, price confirmation is required
when trying to identify reversals. These overextensions may occur at expected
percentage levels or may be formed at levels specific to the stock or market itself.
Overextensions may be identified as follows:
- For Bounded Oscillators:
■ (^) Overbought is represented as relatively high percentage readings, usually at
or above 70 or 80 percent (depending on the oscillator employed)
■ (^) Oversold is represented as relatively low percentage readings, usually at or
below 20 or 30 percent (depending on the oscillator employed)
- For Unbounded Oscillators:
■ (^) Overbought is represented as historical or significant peaks in the oscillator
■ (^) Oversold is represented as historical or significant troughs in the oscillator
The overbought (OB) and oversold (OS) levels for two popular bounded oscil-
lators are defaulted at:
■ (^) Stochastics: OB (80 percent) OS (20 percent)—note that many practitioners
up shift these OBOS levels to OB (90 percent) OS (30 percent) to account for
the upside bias in certain markets or during strong and prolonged uptrends.
■ (^) RSI: OB (70 percent) OS (30 percent)