Two much overused terms in technical analysis are overbought and oversold. Commonly, indicators such as the Slow Stochastic and RSI are used to measure such things. However, there is a huge problem with using these indicators unless you fully understand their limitations, which are covered in my second book, Trading Time: Mapping Your Voyage of Discovery. Primarily, the issue is the fact that you are placing a linear calculation (limit of scale of 1 to 100) on a piece of nonlinear data. Whilst the indicators have limits, price doesn't. Just ask those who were buying oil at 1 cent last week.
This problem is more acute on individual stocks as opposed to other asset classes, as uptrends especially can be relentless and long-lasting. The higher the timeframe chart you use, the more this problem presents itself. The daily chart of Microsoft (MSFT) shows that there was various times when both the RSI and Stochastic were overbought. In fact, when the uptrend began with the gap higher in November, it immediately placed the Stochastic in overbought territory. Equally dangerous is their usage for quantifying Divergence, as the reality is that nearly all trends diverge. It is a cliché, but the trend is your friend, so it is counterintuitive to use methods that will consistently tell you that you should be getting out of the trend (overbought) or, worse still, trade against the trend (divergence). Ironically, when the high in Microsoft was made, whilst overbought for the umpteenth time, there was no divergence in the traditional sense.
Range Relativity's basis once again has its core around Range Deviation Pivots. However, in contrast to Powwerplay/Slammdunk, its concepts return to the application of multiple-timeframe analysis on a single chart. For use on daily charts, its default places the first deviation of the weekly, monthly, quarterly, semi-annual and Annual ranges. Remember that Range Deviation Pivots have an inbuilt skew, meaning that the Pivot levels will be further away from price if that is the current trend. This is an important concept because, as trends develop, the study is by default giving the trend more room to breathe. As a study, it's not pretty and, at first glance, appears indecipherable with a collection of seemingly random lines. However, the raw visualization betrays what patterns and relationships between the lines lie beneath.
Below is the Microsoft Daily chart. Green = Weekly, Red = Monthly, Purple = Quarterly, Brown = Semi-Annual, Yellow = Yearly.
The patterns of Range Relativity (Aggressive and Passive) normally take some time to develop in a trend. This is because it takes the relationship between the weekly, monthly and quarterly levels. The first chart once again shows Microsoft with weekly and monthly levels, concentrating on the recent uptrend. They show the 1st Deviation above and below, remembering that the study is based on the opening of the timeframe, so the the levels are fixed for the length of that time. This allows prior knowledge (being proactive) of what is required to create both patterns and an understanding of exactly how overextended that trend is in relationship to itself (Space). In addition, there is the resetting of the trend as the weeks/months/quarters pass (Time), which allows us to understand when the trend can end (Price).
Starting with Space, I have placed rectangles that show the amount that price has moved above its red upper monthly deviation. The combination of Space and Time provides a far clearer view of how overextended the stock is in relationship to itself, in contrast to using a continuous momentum indicator. Note how the trend just accelerated as time went by.
Moving onto Time, I have now marked at what point in the month that price closed above the monthly level. First, it was mid-month, then the third week on two occasions, before the final acceleration ultimately began on day two!!
If you wish to gauge Time and Space further, you can adjust the Relativity levels from 1 to 3 deviations. It is rare for any stock to reach the third, and how quickly it does it within the timeframe is also important. In January, price topped out at the monthly 3rd one day before the month ended. By contrast, in February, price hit both its monthly and quarterly targets by the second week of the month, just 6 weeks into the quarter. This emphasizes two points. First, if an extreme is reached right at the end of the period, Time can simply reset and give more room for the trend to breathe. However, the second point is that once a trend is established, the earlier it reaches a target in the period, the more overextended it is.
Looking at the recent collapse, the third deviation created a Time-based zone of a monthly and quarterly extreme, whilst this month saw price top out at its quarterly level on the vicious bounce.
Whilst overlaying Range Relativity on a chart is useful, if placed with the Peak Term studies, the chart gets clustered. In order to have a base chart that gets around that problem, there are two sets of code that mark bars called Range Relativity Aggressive and Passive. They have a subtle difference in how a potential signal can be created, but the trigger points are identical. Not surprisingly, Aggressive is more frequent than Passive.
The chart below once again is of Microsoft, with weekly, monthly and quarterly levels. In an uptrend, the setup pattern for an Aggressive signal is as follows: the monthly high level must be above the quarterly high level, and then the weekly high level must be above monthly. Looking closely at November and December, this setup was in place, but no trigger activated. The trigger is when the daily bar closes below the weekly level low.
Moving into January, we see the critical difference that looking at Time-spliced momentum, instead of continuous, can achieve. We know that Range Relativity levels reset at each beginning of a new timeframe and give the trend more room to breathe as the trend accelerates. We also know that January, in terms of Space, saw a significant acceleration as well. However, when looking at the relationship between Time and Price, the beginning of the new quarter simply raised the level to which the stock could become overextended. The monthly high (red) was below the quarterly high (purple), which meant it was impossible for a signal to be triggered.
That all changed in February, as price quickly became overextended once more. It took nearly two weeks before price finally closed below the weekly low on the Friday and produced the Black Triangle, signaling that the pattern was now complete.
Last week, we finished with a Range Relativity positive signal on Boeing (BA). Looking at the chart, the RSI first became oversold just as the downtrend was beginning to accelerate, as circled. Once again, Time Splicing shows how the weekly levels simply reset, allowing more room for price to fall as range expanded. The overextension between the weekly zone and monthly low level reached over $160, which is huge. I like to think of such an extension as an elastic band. The further it stretches, the faster and more violent the acceleration back the other way. Subsequent to the signal, price rallied 80% in just 3 sessions.
Range Relativity Passive, has the same trigger point but the setup is slightly different. It is rarer as the barrier is raised to what can be a signal. In a downtrend, the weekly high must be below the monthly low. In Aggressive it only needs the weekly low to be below the monthly low. The same principle applies to the higher relationship, in that the monthly high must be below the quarterly low. In aggressive, only the monthly low must be below the quarterly low. In this instance, on the first trading day of March, we know that a passive signal is in setup mode as the monthly high is below the quarterly as circled. It produces a Green square at the same point as would a Green Triangle.
This brings me back to the use of Proactive signals that are based on opening values instead of closing. It gives you time to go through different stocks and see which ones are the most interesting. For Range Relativity, once in a setup, you simply have to look at the beginning of the week and see where the signal trigger point will be, then place a Price alert so the opportunity is not missed.
As stated in a previous article, Peak Energy and Peak Expansion LINK are one of the core foundations to the understanding of where support and resistance truly lies. Whilst Range Relativity has properties in its own right as either a profit-taking point or new position (or both at the same time, enabling a Stop and Reverse scenario), the connection between them and Energy or Expansion provides added confluence. Returning to Boeing and the Range Relativity signal, Peak Expansion showed a major monthly-based support just below $100. This support dated back to April 2016, and we know that the longer a level stays the same the more powerful it is. Forewarned is forearmed, and, with this knowledge and the closing level already known at which the trigger can be pulled, allows for greater confidence and a clear understanding of where the trade is wrong. Furthermore, recent analysis shows that a weekly-based Expansion level has joined the longstanding monthly one to create a stronger zone of support and an opportunity if price returns, ready to see if any of the other Fourth Dimension patterns emerge.
We will look at the relationship between Range Relativity and the Time Area study at some point, but, after that marathon, next week, in way of some respite, we will look at the first ever divergence-based indicator I created over 30 years ago. Whilst subsequent Divergence Indicators I have built are far more involved in sophistication and concept, in attempting to quantify this characteristic, the plain simplicity and durability of what I call UFO and POPS are still part of my analytical armoury.
I can be contacted at firstname.lastname@example.org to answer any questions.