Many traders make decisions based on technical indicators; however, the use of most of these tools in normal interpretation usually leads to heavy losses. One such highly underappreciated indicator is the Williams %R. If used improperly, it can drain your trading account in a very short period of time.
Williams %R is a momentum oscillator that measures overbought and oversold conditions in the market. It can range between -100 and 0, where it is sometimes used to signal potential reversals. As expected, however, most traders use this indicator incorrectly by following conventional advice to sell when the market has gone “overbought” and buy when it is “oversold.”
Williams %R is a tool, not a strategy. It will only be useful in case you understand what it truly measures, whereas other strategies base their utmost approach on strategies that are utterly outdated. Buy during what others call “overbought” and sell during “oversold.” That is your counterintuitive approach, helping you to identify market strength rather than misleading reversal points, ensuring you ride the trend rather than miss out on profits.
What Is Williams %R?
Williams %R is a momentum indicator by Larry Williams to help traders find when the market has reached overbought or oversold conditions. It ranges between -100 for a strong oversold condition to 0 for an overbought level. A tradition with some common sense in the trading world is selling when it exceeds -20 (overbought) and buying when it falls below -80, which is a very generalist approach that makes many people lose money.
It is working on a bounded range; thus, values are restricted from -100 to 0, and this is an important piece of information that describes how it works.
Common Misconception: Overbought and Oversold
What attracts many traders is the indication that, once Williams %R moves into the “overbought” region (above -20), the market must now turn; when it falls below -80, they believe the market is “oversold” and is just waiting to bounce back. Such thinking can ruin your strategy.
Here’s why: In strong trending markets, whether bullish or bearish, these so-called overbought and oversold conditions can persist for a long time. For example, if you sell in a bullish trend just because Williams %R shows the market is “overbought,” you’re really working against the trend—often a recipe for disaster. And vice versa: buying in a bearish trend when the market is “oversold” can get you burned up badly.
Truth About Williams %R
The real key to Williams %R is that it does not generate a signal when it touches “overbought” or “oversold” levels. These levels often, but by no means always, mark strength in the trend.
- Above -20, this means the market has strong bullish momentum.
- Below -80, reflects strong bearish momentum.
Thus, instead of a fade at such points, you should continue the trend. Well, if the market is upward and Williams %R is above -20, it is not a time for selling but a sign of keeping long and even more increasing the buying. While in a downtrend of the market and if Williams %R is below -80, then it is actually an indication to keep holding short rather than starting to buy.
This is contrary to intuition yet the secret to squeezing all your profit out of a trending market and avoiding premature reversals.
Why Overbought and Oversold Are Misleading Terms
One of the reasons Williams %R so frequently misleads traders is its terminology: “overbought” and “oversold.” The terms are misleading because they make a trader think the market is overextended and will most certainly reverse at this point. But, by definition, markets can stay overbought or oversold for extended periods of time—especially during powerful trends.
For example, during an uptrend market, it can remain “overbought” for days, weeks, or even months. In such a scenario, selling too early would mean missing potential gains or worse, losing some money while the market keeps going higher and higher.
This is why professional traders do not use the words “overbought” and “oversold.” They are concerned about the strength and momentum of price action. When Williams %R shows strength, above -20 in a bullish trend, or below -80 in a bearish trend, they follow the trend knowing that strong price action usually outlasts the expectations of most traders.
How to Use Williams %R Correctly
Now that you understand the basic flaw in the way Williams %R is traditionally applied, let’s explore a proper application.
Follow the Trend:
Williams %R performs better in a trending market. Before using it, identify the overall direction of the trend up or down with the help of any other technique, moving average as well as price action analysis. In an uptrend, purchase when the Williams %R of the market is higher than -20. In case of downtrend selling occurs when this indicator is lower than -80.
Ignore the Noise:
Just because Williams %R touches “overbought” or “oversold” levels doesn’t mean you should immediately start acting. Wait for confirmation from price action or other indicators before entering or exiting a trade.
Look for Strength, Not Reversals:
William %R measures strength in current price action and not in potential points of reversal. A signal in extreme readings is actually a strength in the current direction rather than some warning that it may be a reversal.
Combine with Other Indicators:
Williams %R may give you an idea where to put yourself so that you find yourself on the good side of the market, but it is not going to help you pinpoint the exact spot at which you must enter. For this, you might want to combine it with a cycle or a timing indicator to pinpoint the best position to get in or out of a trade.
A Real-World Example of Williams %R in Action
Let’s now see how Williams %R might function in a trending market. Suppose the market is in strong uptrend; then Williams %R rises above -20, where it shows the market is “overbought.” Using this methodology, you may go short only to miss subsequent significant price action as you remain overbought for an extended period of time.
Contrary to this case, when the market is trending down and Williams %R approaches the area below -80, one will be wrong to buy. In fact, this is seen as strong bearish momentum, and the right thing to do will be to continue shorting the market.
Conclusion
The key to applying Williams %R is to understand that the overbought and oversold levels themselves do not work as signals for a trend reversal but as a recognition of the strength of the current market trend. You can trade in strong trends using Williams %R, reversing traditional advice, which is excellent at improving your trading performance and avoiding costly mistakes.
Adding it to your trading strategy will more often than not have you on the right side of the market. Trading is fundamentally making the opposite side of everyone else, and what usually separates you from becoming a good trader is having a real understanding of the true nature of Williams %R.
