Tharp's Thoughts Weekly Newsletter (View On-Line)
Williams %R’s Assets and Shortcomings by Ken Long
Stocks in Your Pocket or Purse: The Market Goes Mobile, Part 3 by D.R. Barton, Jr.
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An In-depth Look Williams %R’s Assets and Shortcomings
Understanding The Williams %R Indicator
Oscillators are technical analysis tools used to identify time periods when price can be considered to be in an overbought or oversold condition. Overbought and oversold conditions are found at extremes that vary based on how the oscillator is constructed. Some oscillators look exclusively at price with respect to the range of high and low in the look back period. Others incorporate some measures of statistical description. In most cases, the look back period is required in order to establish what may be considered normal and extreme for the price channel.
Depending on the market condition, your strategy could be one of channel trading in which case you expect price to reverse once it’s in this extreme condition or one of preparing for breakout trades in which case you expect price to continue explosively through this extreme moment and breakout of the channel.
The famous technical analyst, Larry Williams, created the Williams %R indicator as an index ranging from zero to -100 for the look back period. The highest high of the look back period earns an index score of zero and the lowest score earns a -100. Then, look back period is segmented into 100 equal sections and the oscillator value of the price is interpolated.
Readings between zero and -20 are considered to be overbought because they are in the top 20% of price, whereas readings between -80 and -100 are considered to be oversold because they are in the bottom 20% of price during the look back period. Readings between -20 and -80 are considered to be in the normal range of the channel.
Williams %R is my favorite oscillator because it is simple to understand and very visual.
I use Williams %R as a useful oscillator in determining if a particular instrument might be considered overbought or oversold based on the context of recent price action in a defined period. I like to use 10 days and one year for context.
I use the 10 days of look back to give me insights into short-term trader psychology and I use the one year look back period to give me insights into long-term trader psychology. In some of my systems I combine both of these measures to give me a consolidated, integrated look at market psychology.
There’s nothing magical about the use of these two specific time frames, nor do I believe that they have any predictive power. I simply find them useful to help me frame my trades and understand the market enough so that I can take action.
I have not exhaustively analyzed different time frames to see if there is an incremental advantage for adjusting the parameters. These two periods work well enough to get me into the ballpark for decent trading opportunities.
Recently, I have seen some trading systems with simple rule sets built exclusively from Williams %R that use a 30-period look back rather than the standard 10. I’ve only looked at the rule sets superficially: while the entries made sense, the exits looked clumsy and non-intuitive.
Although I consider Williams %R an excellent technical indicator, it is by no means perfect. I dislike the scale because it seems counterintuitive to me. It goes from a high of zero to -100. I also don’t like that it uses today’s price action when calculating the index value. Normally, this is good enough; however, there are days when the price of the asset has makes a bold break out from the last 10 days trading range and this indicator doesn’t help me recognize the breakout.
If I were going to design this indicator from scratch, I would fix those two problems. First, I would make the scale read from 0 to 100 like a thermometer. Second, I would describe today’s price action on a normal scale of 0 to 100 that looked back 10 days starting from yesterday. For example, if today’s price exceeded the highest high of the last 10 days, the indicator would have a reading greater than 100. Conversely, if it had a lower low than the low of the last 10 days, it could have a negative reading. This change would allow you, by inspection, to identify breakout candidates in both directions as well as a relative magnitude of the breakout, depending on how far below 0 or how far above 100 the new reading stands.
Re-engineering An Indicator
To support my own trading I built such an indicator in Microsoft Excel and I use it for analyzing a large numbers of stocks and ETFs as part of my daily trading practice. I have found the modified indicator, which I call NDX (or “index”), does everything that Williams %R does and fixes its two shortcomings.
In my spreadsheet reports, I use the NDX(t), where “t” represents the look back timeframe. For example, NDX(10) would represent a 10-day look back period from yesterday to 11 days ago, with today being represented as the zero day.
If an instrument traded in a price range from $10 to $20 in the look back period, and closed today at a price of $10, it would have an index value of zero. If it closed today at $20, the index value would be 100. If the close today were $21, the index value would be 110, which would indicate a breakout of 10% greater than the previous trading range.
You can see how this information could be very useful scanning for breakout opportunities in a large population of stocks and ETFs. The normal 0 to 100 scale is also much more intuitive to me.
I use conditional formatting in Excel to highlight index values greater than 90 in green and less than 10 in red. I typically rank sets of symbols from highest to lowest or lowest to highest in order to find those at the most extreme condition compared to their peers. This is consistent with the use of oscillators in general, and I have found it very useful to focus on these extremes for short-term trading targets.
When I use a year-long look back timeframe, I write the column header as NDX(52w).
I still use Williams %R whenever I use commercial or public stock screeners. I use my NDX indicator on my spreadsheet reports.
These kinds of refinements come from a deep understanding and appreciation for the construction, use and limitations of conventional technical analysis. The refinements don’t seem important unless you understand a specific indicator at a deep level. Attention to detail will reward your practice of trading.
About the Author: Ken Long is a retired Lieutenant Colonel in the U.S. Army with a Master's Degree in Systems Management. He is a doctoral candidate researching the management of uncertainty and an active trader. He is a proud father of 3, a husband, teacher, student and martial artist. Ken is also a dynamic workshop instructor for the Van Tharp Institute. The above article was reprinted from Ken's blog. Read more of Ken's essays at http://kansasreflections.wordpress.com.
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Stocks in Your Pocket or Purse:
The Market Goes Mobile, Part 3
In the past couple of weeks, we’ve been looking at the fast growing field of mobile phone apps for the financial markets.
In the coming weeks, we will dig into the inner workings of half a dozen or more stock market apps that are available for the iPhone/iPad/iTouch. With a user base of over 100,000,000, the iPhone is the logical place to start our smart phone app review. We’ll cover the Android platform in a subsequent series of reviews.
In our last article, we looked at a breakthrough app that offers professional level stock analysis on a smart phone. The Chaikin Power Tools app doesn’t just monitor your portfolio or draw charts, it actually produces a buy, sell or hold conclusion by using a decision algorithm based on portfolio level testing. It passed rigorous third party testing to prove that it provides statistically significant outperformance of the market.
A Model that Works
While the Chaikin Power Tools app is visually appealing, when you look under the hood, you quickly find the beauty is more than skin deep. The app ranks almost any stock you enter on a five point scale:
• Very Bearish (lowest rating)
• Neutral (medium)
• Very Bullish (highest rating)
This rating is driven by a well-tested and well thought out analytical model. It is based on a 20-variable model that captures the best indicators from fundamental, technical and sentiment analysis.
The apps originator, Marc Chaikin, based the indicator set on 40 years of Wall Street experience and almost as impressively on exhaustive testing. While writing this article I spoke with Marc who said his team considered hundreds of characteristics but eliminated any indicator that didn’t add value. Marc said that many traditional Wall Street standards, like trailing 12 month earnings, didn’t test well.
After the rigorous examination, the framework that was left impressively outperformed the S&P 500 and the Russell 2000 in a statistically significant, proprietary analysis by a third-party .
The app breaks 20 variables into four rating areas and the strength of each area displays on main app page for any stock chosen. In the image below, you can see the overall ranking (Bullish or fourth higher on a scale of five) and the four categories for the underlying metrics: Financial Metrics, Earnings Performance, Price/Volume Activity and Expert Opinion.
By clicking on any one of the four categories listed above, you can see the five sub-factors that drive the rating in that area. Below is an example of Price/Volume Activity Rating, which is another way to say the technical analysis of the stock.
Here you see the key factors for the technical picture of the stock. I have written previously about Chaikin Money Flow and the Chaikin Oscillator—common indicators in my tool kit and ubiquitous in almost any reputable charting package. If you’d like more information on this useful indicator, go to stockcharts.com and look under the Chart School tab. Stockcharts.com’s Chart School is another great no-cost resource!
The other three areas have the same level of detail and contain fundamental data and a section on sentiment analysis (dubbed Expert Opinions in the app).
Test Drive This App
As a reader of Tharp’s Thoughts, you can be one of the first to try out the app. As I said in the last article, this app is brand new. During the initial launch phase, it doesn’t cost anything. Get it for free while you can! If you have an iPhone, an iPad or an iTouch, go to the Apple App Store and search for “Chaikin”—you’ll find it there. The app has only been available for a couple of weeks, so you’ll be one of the first to give it a test drive. The app has already been featured in Barron’s “Electronic Investor” section and was the topic of a front-page article in the Philadelphia Inquirer business section this past Thursday. Now you too can be on the leading edge of apps for your phone!
I’m anxious to hear what you think about the app as an analysis tool. And knowing the quality of the researchers that read this newsletter, I’m sure you’ll be finding more ways to use this rich tool than I can imagine.
I’ve known Marc for over a decade and some time back, he asked me to look at an early prototype of the app. It simply blew me away. Even in preliminary testing, I was completely impressed with what it offered traders.
In full disclosure, I am an early and very minor investor in the project. To paraphrase famed Remington razor company owner Victor Kiam from his advertising, “I liked it so much I invested in the company.”
Next week we’ll look at a couple of apps that have some very useful characteristics (like real time data and visually appealing charts).
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