Identifying When a Market is About to Change Direction One summer, with a quill pen and some parchment paper, Isaac Newton created calculus and also unraveled much of the mystery of the physical laws that drive the cosmos.
Several hundred years later, Albert Einstein - who allowed as how he did it standing on Newton's shoulders - unraveled more of the secrets that are the forces behind the operation of the universe.
But even though Albert spent most of his post-relativity life searching for a theory to link all the forces of physics, that equation - if it exists - remains undiscovered.
On a less cosmic scale, a similar undertaking continues regarding knowing when the market's stocks and options have entered a state of terminal exuberance or dismay...
overbought or oversold territory that signals a change in direction is upon us.
An overbought-oversold signal that works perfectly would obviously mark the end of the stock market, since if tomorrow's prices were known with certainty, no one would ever take the "wrong side" of a trade.
That said, real progress has been made in producing technical indicators that do greatly increase the probability of successfully forecasting when a market is likely to be at or near a top or bottom, and that a change in direction is likely imminent.
One such indicator in particular, saddled with the unglamorous name "Williams %R," ranks high with sophisticated stock and options investors.
It is the secret weapon of many very successful stock and option traders.
Conservative investors seeking monthly income through vertical spreads (credit spreads) will find this tool especially helpful because their time frame is necessarily relatively short - usually 2-8 weeks from initiation to conclusion of the trade.
The Williams %R Signal Williams %R depicts the current day's closing price relative to the high and low points of the past days (usually 10 days) in graph form.
You can bring up this graph for any underlying stock, index, or ETF, just like any standard chart, at most brokerage firm websites.
The right hand scale of the graph - the vertical axis - depicts values from -100 (the bottom of the graph) to 0 (the top of the graph).
The current Williams %R value is always between 0 and 100.
You can ignore the minus sign.
The interpretation is that when the graph's line intersects the vertical axis at extreme upper range readings near 0, a "very overbought" market is being signaled; extreme lower range readings near 100 scream "very oversold.
" Williams %R is a very muscular oscillator technical indicator by itself, but you can bring additional power to bear by adding a filter or two to the analysis.
Adding these two entry filters can further strengthen your trade 1.
The 200-day simple moving average (SMA) If we limit our trades to those where our contemplated trade is in the direction of the general trend, the already powerful predictive ability of Williams %R may well be further improved.
By overlaying a 200-day moving average onto the Williams %R graph, you can see at a glance if the Williams %R "signal" is particularly attractive in terms of the current trend.
Basically, what might rationally further encourage you to act on the signal is when Williams %R now signals a very oversold market...
but when the 200-day trend remains bullish.
This scenario would point toward a bull put credit spread.
Similarly, when Williams %R signals a very overbought value for a market that is trending down, a short position via a bear call spread would be the logical approach.
2.
Support and Resistance as a Filter The bell is really ringing loudly for the trade if, in addition to getting the Williams %R signal, with the signal being in conformity with the trend based on the 200-day moving average, we also have this further encouraging confirmation: the Williams signal comes with the underlying price being at or near a significant chart support or resistance level (support if we are going to go long or resistance if our interest is on the short side).
Conclusion It is safe to say that there is not, nor will there ever be, a "holy grail" market indicator to provide total certainty you are entering a profitable trade.
However, the Williams %R oscillator, together with 2 simple filters, can be a tremendously effective tool for increasing the probability of a successful option credit spread trade, or the outright purchase of an option, stock or ETF.